Purchasing or refinancing a home is the single largest financial decision most people make. In fact, a mortgage payment is likely the largest monthly expense for most people, especially towards the beginning of the mortgage (over time the mortgage payment will become easier and easier to pay due to inflation). One of the easiest paths to becoming rich is to keep your costs under control, and with the mortgage payment being one of the largest costs, choosing the right mortgage rate is incredibly important.
Is the lowest rate the best? It depends.
Let’s say you’re presented with three different mortgage
rates: 3%, 4%, and 5%. At first glance,
the lowest rate appears to be the most appealing, after all, a lower the rate
means a lower monthly payment.
Unfortunately, to lock in the lowest rate, you’ll be required to pay
points. Points help
reduce the interest rate in exchange for cash up front. In a sense, you’re buying a lower rate.
Well then, is it worth paying points up front for a lower
interest rate? To decide whether it’s
worth it, you have to ask yourself how long you plan to live in your home. The longer you live in your home, the more
time you have to allow the low interest rate to pay off your upfront investment
in points. The shorter you live in your
home, the less time you’ll have for the interest rate to pay off your points. Here is a general guideline:
How Long Will you live in your house
|
What rate should I choose?
|
A few years
|
Highest rate
|
Maybe 5-8 years
|
Middle rate
|
The rest of my life
|
Lowest rate
|
Here’s an example with a $100,000 mortgage:
Rate
|
Points
|
Cost of points
|
Best deal
|
5%
|
-2
|
-$2000 (you
get money!)
|
First 39
months
|
4%
|
0
|
0
|
Month 40
|
3%
|
2
|
$2000 (you pay money)
|
Months 41 to
the end of the mortgage
|
In this example, if you sold your home after 3 years, the 5%
rate would have been the best financial decision. If you sold your house after 15 years, the 3%
rate would have been the best.
Evaluating the best rate
Be honest with yourself and remember that life is full of
surprises. What if you lose your job and
you need to move to a new city? What if
you start a family and a single bedroom condo no longer makes sense? Picking a lower interest rate can cost
a lot of money up front and if you have to sell early on in your mortgage,
chances are you will have wasted a lot of money on an interest rate that you
were unable to take advantage of for a long enough time to pay off the points. If you’re settling down with a family and things seem
relatively stable, a lower interest rate may be your best bet.
Use this as a general guideline to choose your mortgage rate. There are several calculators online that will help you lock on the specific amount of time it takes to pay off the points.
