Lenders provide a great deal of guidance, but you make the final decision about whether you’re getting the best loan you can get. Part of taking that responsibility involves comparing interest rates. Mortgage interest rates change daily based on a number of national and international economic factors.
The current national rate is posted at left on this page. You’ll note that last week’s and this week’s rates are included, indicating whether rates are moving up or down for the week. You can find longer-range forecasts in business newspapers and on Web sites.
Use our calculators to see how easily you can check the effect of different rates. You can see what monthly payments may look like on different loan sizes at different rates. However, the total cost of a mortgage involves more than just the basic interest rate. Origination fees, discount points, other miscellaneous costs, and other terms and conditions may affect the ultimate cost of your mortgage.
When you are comparing different mortgages, do your best to be sure that you’re taking into account all the factors that can influence your final costs. The lowest mortgage rate may not necessarily be the best choice. Ask lenders these questions:
- What are costs for origination fees?
- What are the costs for discount and origination points?
- What fees does your rate quote include?
- What is the annual percentage rate (APR) of the loan?
The APR is computed based on all the major costs of your loan, not just the loan amount. It usually includes points, origination fees, and other costs associated with the processing of your loan. Be sure to ask lenders which fees are included in their APRs, and try to compare APRs that include the same fees. This will help you determine the most accurate rate you would actually pay.
Virtually all mortgage loan repayment schedules are computed based on a compound interest formula. In the beginning of your repayment period, you are paying little on the principal, so if your annual interest rate, say 6 percent, is added to your balance every month, your principal balance doesn't go down very much.
So if your balance is $100,000 and interest is compounded monthly, it's like adding $6000 to 100,000, then adding 6 percent of $106,000 ($6,360) to the 106,000 (112,366) , then adding 6 percent of $112,366 to the 112,366, and so on every month. This example is oversimplified (because you usually do pay a little on the principal at the beginning), but it gives you an idea why it takes so long to pay off a mortgage loan and why you end up paying a lot of interest over a 30- or 15-year period.
The moral of the story is it's not just the interest rate you pay that matters but how often it is compounded. (Sometimes these two factors together are called the "effective interest rate.") You should get this information from the lender. If your interest is compounded frequently, such as weekly, you may want to shop around and see how often interest on loans from other lenders is compounded.
By paying a lump sum of money to the lender at the time you close on loan, you can lower the interest rate. That sum is measured in "points." One "point" is equal to one percent of the principal amount of the mortgage. (One point on a $100,000 loan would be $1,000.) You should know how points and other terms and conditions affect the total cost.
On most types of loans, lenders offer mortgages with several combinations of points and interest rates. Generally, the lower the interest rate, the more points you will pay at settlement. Interest rates affect your monthly mortgage payment, while the points affect the amount of cash you must have at the closing.
For example, if a loan with the current market interest rate has two points, a loan with an interest rate that’s one-half percent higher than the market rate may have no points. Your choice among the various interest rate/points options will depend on how much cash you have available for the closing and settlement.
As you discuss your options among different mortgages, be sure you ask how and when the final interest rate you pay is determined — or when your rate is "locked."
Most lenders will quote a rate and fees at the time you apply for a loan, and then guarantee—or lock—the quote for a specific time. While this lock protects you from paying more for your mortgage if interest rates rise before you close on the loan, it also means you will pay the quoted rate even if interest rates fall.
Lock periods usually run from 10 to 60 days. Longer periods are sometimes available for an additional fee. You generally will want your lock period to be long enough to get you through closing and settlement.
Some lenders, however, will give you the option of letting the interest rate for your mortgage "float," so the rate can change between the time you apply and the time you close (although the rate is usually set after some specific period before the actual closing).
Allowing the rate to float enables you to benefit from reduced interest rates if interest rates fall between the time of your application and closing. But before you choose a float, make certain that you have the resources to cover a higher monthly payment if interest rates should go up. Otherwise, you could be denied your mortgage.
A “no-cost" mortgage is one in which you are allowed to pay some or all of the discount points and other closing costs over time instead of paying them in cash at closing. The lender may refer to this as financing the finance charges. As with all financial transactions, you need to understand how this option will address your particular needs over the long and short term.
No mortgage is truly without costs. By choosing a "no-cost" mortgage, you pay a higher interest rate on your loan in exchange for reducing the amount of money you will need at closing. Generally, the interest rate on a “no-cost” mortgage ranges from half a point to a full point above the market rate.
Fees commonly financed and paid by the lender in a no-cost loan include points and processing fees and fees for credit reports and appraisals. (A “point” is 1 percent of the outstanding principal balance of a loan.) A “no-cost” mortgage makes the most sense when you are likely to move or refinance within a relatively short period. The following example shows why.
You want to refinance your $150,000 mortgage with a 30-year fixed rate loan, and you have two options. Under loan A, you would receive a mortgage at 7 percent with fees of $2,500. Under loan B, you would have a “no-cost” mortgage at 7.5 percent. (This example assumes the costs for each loan are identical, but that might not be the case in real life as lender programs may differ.) You will pay $998 per month on loan A. You will pay $1,050 per month on loan B, or $52 more per month.
After four years (at 49 months), the total of the extra amount ($2,548) you've paid on loan B will exceed what you saved at closing ($2,500). Unless you sell your home and pay off loan B or refinance loan B to obtain a lower rate mortgage, you will pay considerably more for loan B over the life of the loan. If, however, you sell or refinance at a lower rate after three years, you may save money by having avoided the out-of-pocket costs at closing UNLESS your mortgage carries a prepayment penalty.
If cash is very tight at the time of closing and you are confident that you can make the higher monthly payment and that the home will increase in value over time, the higher payment of a no-cost mortgage may still be okay for you, even if you can’t refinance at a lower rate after the fourth year. However, if you have the cash available, it may make sense to opt for the lower interest rate mortgage and pay the discount points and fees in cash at closing. Other points to consider:
- You need to check whether a “no-cost” loan carries a prepayment penalty to discourage you from refinancing as soon as you can find a lower-rate mortgage. Prepayment penalties may require you to pay six months of interest or a percentage of the outstanding principal balance of the loan.
- Check exactly what fees may be waived on a “no-cost” mortgage. Chances are you will still need to pay escrows for hazard insurance and property taxes, local transfer taxes, daily interest from the closing date to the first day of the next month, and perhaps other items at closing.
- Don’t confuse “no-cost” mortgages with “no-cash” mortgages. With “no-cash” mortgages, the closing costs are added to the outstanding principal balance of the mortgage, not to the interest rate. This means that you are borrowing more money than you would under a no-cost or regular mortgage and paying interest on it over time.
A note about loans with pre-payment penalties. Pre-payment penalties can be part of most types of loans, so be sure to ask your lender whether your loan carries one. Generally, loans with pre-payment penalties offer lower initial payments in exchange for a promise to pay the additional lump sum if the borrower refinances prior to a date specified in the mortgage. The amount of that lump sum is also specified in the mortgage. If you think you will refinance, you may not want a pre-payment penalty on the loan.
For instance, a 2 percent prepayment penalty could be a significant amount of money — for every $100,000 left on your loan balance, you would have to pay $2,000. The best way to make a decision on whether or not to pay the penalty is to compare the cost of the penalty to the difference in your payment now and what the payment will be after you refinance.
For example, if the refinance transaction costs $3,000, and it would save you $300 a month, it would take you 10 months to recover the cost of the transaction. Generally, if you can recover your costs within a year, or if you are reducing the interest rate on your mortgage by 2 percent or more, refinancing is a good option even with the pre-payment penalty.
Any time you refinance, it is important to look at the savings on your monthly payment vs. the cost of doing the refinance. (In this case, it would involve the cost of the pre-payment penalty plus closing costs on the refinance transaction.) After that, you need to determine how long it will take you to get back what you paid to do the transaction.
You should understand all the terms of the mortgage you choose, so you won’t be surprised down the road. That’s why it’s so important to choose a lender who makes you feel comfortable and welcomes your questions. Mortgages are complicated financial transactions, but lenders are experienced in explaining ins and outs to home buyers.