How a Low Interest Rate Can Cost You Money
It's easy to assume that the lowest interest rate when you buy a house or when you refinance, equals the best deal.
The truth is that they are usually wrong.
The media, well meaning friends and family members, as well as uneducated lenders have added to the belief that lowest rate equals the best deal.
Its easy to see how this idea got started, since a lower rate means a lower monthly payment.
Additionally, a rate 1/8% lower can literally save you thousands over the life of a loan.
However, the life of a loan is typically 30 years, and the truth is that not many people keep a loan for that long, which means that the perceived savings is often just that...
perceived.
There is a fundamental rule to have in mind as you chose your loan, a lower interest rate will have higher closing costs and a higher rate will cause the opposite, lower closing costs.
Of course, different companies do have different rules but over all, this rule applies anywhere.
So, let's break it all down.
Let's take a $200,000 loan with 2 different rates and compare the actually vs.
perceived savings and then we'll compare the long term and the immediate savings.
Loan #1 chooses an interest rate of 4.
5% along with the traditional origination fee of 1%, or $2,000.
The monthly payment will be $1,013 not including taxes and insurance.
Loan #2 chooses a slightly higher rate of 4.
75% and no origination fee.
Their monthly payment will be $1,043 (again without taxes and insurance).
You'll notice that there is a monthly difference of $30, but loan #2 has already saved the buyer $2,000 in closing costs, since they didn't pay an origination fee.
Loan #1 will take 66 payments to be equal in savings to loan #2! In addition, statistics show that most home owners only keep a loan 3-5 years before they refinance or sell their home.
So in most cases, the savings is never recouped.
But wait, there is more! Let's say that the buyer for loan #2 decides to take the $2,000 that he saved on closing costs and applies it to the loan balance.
Now they also owe $2,000 less and the payment drops to $1,032, now just barely $20 more than loan #1.
Now loan #1 will need to make 96 payments, or roughly 8 years to equal the savings of loan #2.
But that's still not it! Monthly interest on a home mortgage is tax deductible...
closing costs aren't.
So the buyer that is paying the higher rate will also have a bigger tax deduction.
Let's say our buyer of loan #2 is in a twenty percent tax bracket.
That means that of the extra $20 he pays each month, $4 will come back to his pocket at tax time.
In actuality, he is only paying $16 more, thus loan #1 will need over 10 years to break even with the higher rate.
So, it becomes obvious that more than just a low rate needs to be considered when you are thinking about buying a house or refinancing.
What you really need is a lender that can tell you what I just told you!
The truth is that they are usually wrong.
The media, well meaning friends and family members, as well as uneducated lenders have added to the belief that lowest rate equals the best deal.
Its easy to see how this idea got started, since a lower rate means a lower monthly payment.
Additionally, a rate 1/8% lower can literally save you thousands over the life of a loan.
However, the life of a loan is typically 30 years, and the truth is that not many people keep a loan for that long, which means that the perceived savings is often just that...
perceived.
There is a fundamental rule to have in mind as you chose your loan, a lower interest rate will have higher closing costs and a higher rate will cause the opposite, lower closing costs.
Of course, different companies do have different rules but over all, this rule applies anywhere.
So, let's break it all down.
Let's take a $200,000 loan with 2 different rates and compare the actually vs.
perceived savings and then we'll compare the long term and the immediate savings.
Loan #1 chooses an interest rate of 4.
5% along with the traditional origination fee of 1%, or $2,000.
The monthly payment will be $1,013 not including taxes and insurance.
Loan #2 chooses a slightly higher rate of 4.
75% and no origination fee.
Their monthly payment will be $1,043 (again without taxes and insurance).
You'll notice that there is a monthly difference of $30, but loan #2 has already saved the buyer $2,000 in closing costs, since they didn't pay an origination fee.
Loan #1 will take 66 payments to be equal in savings to loan #2! In addition, statistics show that most home owners only keep a loan 3-5 years before they refinance or sell their home.
So in most cases, the savings is never recouped.
But wait, there is more! Let's say that the buyer for loan #2 decides to take the $2,000 that he saved on closing costs and applies it to the loan balance.
Now they also owe $2,000 less and the payment drops to $1,032, now just barely $20 more than loan #1.
Now loan #1 will need to make 96 payments, or roughly 8 years to equal the savings of loan #2.
But that's still not it! Monthly interest on a home mortgage is tax deductible...
closing costs aren't.
So the buyer that is paying the higher rate will also have a bigger tax deduction.
Let's say our buyer of loan #2 is in a twenty percent tax bracket.
That means that of the extra $20 he pays each month, $4 will come back to his pocket at tax time.
In actuality, he is only paying $16 more, thus loan #1 will need over 10 years to break even with the higher rate.
So, it becomes obvious that more than just a low rate needs to be considered when you are thinking about buying a house or refinancing.
What you really need is a lender that can tell you what I just told you!
