Why the Lowest Interest Rate Is Not Always the Best Rate
We all know that interest rates change over time. Too many uninformed home buyers only rate shop thinking a low rate is everything. Believe it or not, there are times when you will pay more with a lower rate.
To understand how this happens, let’s start from the beginning of the mortgage process and talk about how an interest rate is determined in the first place.
On any given day, there are a variety of factors that can impact your interest rate:
Home price and loan amount: Your home price minus your down payment will determine how much you’ll borrow which helps decide how much the interest rate will be.
Down payment: Generally, a higher percentage down payment equals a lower interest rate. The more money you put down, the more stake you have in the property.
Loan term: Shorter terms (like a 15-year or a 20-year) generally have smaller interest rates than a 30-year term.
Interest rate type: Interest rates come in two basic types: fixed and adjustable. Fixed rates do not change over time. Adjustable rates, on the other hand, have an initial fixed period then go up or down based on the market. For example, a 5-year ARM loan will have a fixed-rate for the first 5 years and then the rate will fluctuate from the 6th year onward.
Loan type: Different categories of loans (like conventional, fixed-rate, FHA, etc.) have different rates.
Credit score: Primarily based on credit report information usually sourced from credit bureaus. Typically, this is called your FICO score and is based on your credit history.
Quick tip: Every lender will charge fees for processing your mortgage, loan origination, and typically an appraisal on the house you want to buy. The key here is to work with someone who doesn't hide fees. Complete transparency throughout the home loan process is essential.
So, what’s the best interest rate then?
To put it simply, it’s the mortgage rate that saves you the most money once you factor in fees, closing costs, and loan terms. Obviously, interest rates are important, but they’re not everything when it comes to home loans. You also need to take a close look at the annual percentage rate (APR).
While interest rates and annual percentage rates are related, they are not the same, but you will see both listed for mortgages.
The interest rate is the interest you will pay on your home loan.
The APR is the interest rate PLUS other fees and costs associated with buying a home, so this is what you’ll end up paying on top of the principal (or the amount you borrowed for your mortgage).
Reminder: Fall in love with the numbers before you fall in love with the house! ???
APR can be confusing, so let’s break down what the APR on a fixed-rate mortgage typically includes:
Interest rate: The cost you’ll pay each year to borrow the money on your home loan. In this case, the lower the interest rate percentage, the more you’ll save over the life of your loan (which is a good thing, of course). Many homeowners choose to “lock” their interest rates 60-90 days before closing on their home loan to avoid potentially rising rates.
How to Lock a Rate: Churchill offers a 30-day rate lock program and a 90-day Rate Secured program (which caps your rate for 90 days and gives you the option to reduce your rate if rates go down.
Origination fees: Origination fees are charges that you will pay for a lender to originate your loan. They are not upfront fees – they’re paid on closing day. One lender may quote you a lower interest rate to frame the loan to be more appealing, however, that lender may also be charging higher origination fees to compensate for the lower rate.
Quick Tip: When comparing loan quotes from different lenders, the best thing to do is look at Section A of your Loan Estimate to really understand what each lender is charging.
Discount points: These are also called mortgage points. It is a charge that you may incur based on the interest rate and/or the terms of your loan, credit score, etc. One discount point is 1% of your total home loan amount.
For example, on a $300,000 mortgage, one point would cost you $3,000 directly out of your pocket on closing day. Keep in mind, this money is in addition to your down payment and adds to your total closing costs. It’s also important to note that paying one discount point does not equate to a 1% lower interest rate.
The charge for discount points may differ between loan programs and lenders. You can pay mortgage points and not get any reduction on your interest rate so you really need to pay attention to the fine print to understand why a rate may have discounts points and other rates may not.
Rule of Thumb: The more discount points included in your mortgage rate, the lower your quote will be because you are paying more money upfront.
Other costs associated with financing your home loan, like closing costs: When you’re buying a house or getting a mortgage refinance, closing costs are part of the contract. The average home buyer pays about 2-5% of the loan amount in closing fees. So, what’s included in closing costs? Usually you’ll have a variety of fees such as: your application fee, attorney’s fees, administrative or processing fees, insurance fees, property taxes, and expenses from the title company.
Keep in mind, by law, the APR must be disclosed in any loan agreement, and on all advertising for loans that specify an interest rate. If you see an advertisement that lists a super low interest rate, with no APR in sight, it’s probably best to steer clear.
Fast Fact: The APR does not change the amount you borrow, but it's important to note that the better the APR, the lower your monthly payment will be.
The bottom line.
One of the most important things you can do when buying a new home is to sit down and look at the real numbers. The lowest interest rate doesn’t always get you the best deal, so don’t get too excited about an interest rate before you do the math. It’s important to take the time to talk to an actual human (who is a qualified home loan expert) to make sure you understand the options that benefit you most.
Ready to crunch some real numbers? Talk to our of our Home Loan Specialists today!