Closing Costs vs. Interest Rate…How to Choose?

photo credit: TW Collins

Once you feel comfortable that you have a mortgage professional who can advise you, here are some secrets for shopping effectively.

First, just like anything else IF IT SEEMS TOO GOOD TO BE TRUE, IT PROBABLY IS. No one has a commodity on rates- interest rates all come from the same places, and if the rate sounds really unbelievable, ask a few more questions. Is there a prepayment penalty? Are there extra fees? What is the length of the lock-in agreement? If fees are discounted, is it built into a higher interest rate?

Second, YOU GET WHAT YOU PAY FOR. If you are looking for the cheapest deal out there, understand the risks, especially with the recent credit crunch you need a TRUE PROFESSIONAL on your side someone who is checking guidelines and is up to speed on the market changes. We have all heard the horror stories from friends and family about missed closing dates, or surprise changes at the last minute on interest rate or fees…usually due to working with discount or internet lenders who may have a serious lack of experience. Remember, the cheapest rate on the wrong strategy can cost you thousands more in the long run.

Third, MAKE CORRECT COMPARISONS. When looking at estimates, there is more to it than just the bottom line. You must compare apples to apples the Lender fees are the only costs that the Lender controls all other fees are third party costs. You may be familiar with the term “junk fees”. All Lenders have a fee to process your loan- simply the cost of doing business. Many Lenders have both a processing fee and a funding fee, typically these fees together do not exceed $1,200. If you see a number of other Lender fees listed I would ask your Mortgage Professional for more information.

A Lender is responsible for quoting the other fees associated with a mortgage loan such as title insurance, hazard insurance, appraisal, days of interest., ect.. Keep in mind since they are third party costs – they are often under-quoted up front by a lender to make their bottom line appear lower. Keep your eyes out for these discrepancies and be sure to ask questions about fees you do not understand.

Lately we have seen hidden discounts fees that are NOT included in the bottom line estimate. This hidden fee will appear in small print typed at the bottom of a good faith estimated “X” discount point to be charged ect… again- if it seems to good to be true it likely is.

Fourth, UNDERSTAND THAT INTEREST RATES AND CLOSING COSTS GO HAND IN HAND. A good way to view loans is either Cost, No Cost or Shared Cost– if you are looking for a no cost loan understand that this comes at the expense of a higher interest rate- there is no free lunch. It all depends on what your goals are.

For instance:

How long will you be in the property?

Are you close to retirement?

Is this your primary residence, 2^nd home or an investment property?

What’s more important to you right now cash on hand or a lower monthly payment?

Do you have any life changing events coming up a baby or kids leaving for college?

Is the seller paying any of your closing costs?

A professional advisor will be able to offer the best advice in terms of the balance between interest rate and closing costs that correctly fits your personal and financial goals.

Sample Analysis:

$250,000 Loan with 1% Origination Fee = $2,500 at 5.875% = $1,478.84 principal & interest payment

$250,000 Loan with 0% Origination Fee = $0 at 6.125% = $1,519.03 principal & interest payment

Difference of $40.19 per month divided by $2,500 = 62.20 months or 5.18 years to recoup my costs

Fifth, UNDERSTAND THAT INTEREST RATES CAN CHANGE DAILY, EVEN HOURLY. This means that if you are comparing Lender’s rates and fees – this is a moving target on an hourly basis. In order to have an accurate comparison – you must get these quotes within less than an hour of each other. Be sure the terms are the same- product and program. You also must know the length of the lock you are looking for, since longer rate locks typically have slightly higher rates.

As this is likely one of the largest financial purchases you will make- be smart, ask questions, and seek the advise of a professional advisor not just some one who will quote you the lowest rate out there.