You’ve certainly heard by now that buying a home will be the most expensive single item you’ll likely ever pay for, but did you know the initial purchase price is only one part of the cost?
The other part? Your mortgage interest rate.
Shopping for a home loan can sometimes be frustrating, so it’s understandable if, instead of gutting it out and seeing if you can knock just a bit more off your loan rate, you go with the first “pretty good” offer you can find.
After all, 4.5% is only half a point more than 4.0%. And it’s only a quarter percent more than 4.25%.
That half or quarter percent isn’t going to make that much of a difference. Right?
And it’s not like you don’t have a zillion other things on your Big Giant To-Do List of Future Homeownership.
Unfortunately, as we’ll see below, even a difference of a quarter-percent can add up to big savings over the life of your mortgage.
To plug in loan-rate values for yourself, you can use an online mortgage loan calculator. The one listed here (you can Google the phrase and have dozens of other links to click on), lets you include PMI, homeowners insurance, HOA fees, and property tax so you can determine your total monthly cost (not counting utilities and any maintenance/upgrade work you may undertake).
So, let’s start plugging in some numbers.
The median home price in the U.S. when this article was written was $199,200, but we’ll round up to $200K for easier math.
If we assume you’ll be putting the standard 20% down on a $200,000 property then a $160,000 30-year mortgage at:
3.5% will equal $718.47/month and $258,649.20 over the life of the loan.
3.75% will equal $740.98/month and $266,754.58 over the life of the loan.
4.0% will equal $763.86/month and $274,991.21 over the life of the loan.
4.25% will equal $787.10/month and $283,357.38 over the life of the loan.
4.5% will equal $810.70/month and $291,850.74 over the life of the loan.
As you can see, a difference of just one percentage point will only cost you about 92 bucks extra a month (~$1100 for a year), but over three decades “just” $92 a month comes out to over $33,000!
And even a quarter-percent difference will cost you an extra $8K and change.
30 vs. 15
We did the math for a 30-year loan, but what if you opted for a 15-year mortgage instead? How much can you expect to pay (and save) by cutting your loan-time in half?
If we stick with 20% down then a 15-year, $160,000 mortgage at:
3.5% will equal $1143.81/month and $205,886.17 over the life of the loan.
3.75% will equal $1163.56/month and $209.440.06 over the life of the loan.
4.0% will equal $1183.50/month and $213,090.12 over the life of the loan.
4.25% will equal $1203.65/month and $216,656.18 over the life of the loan.
4.5% will equal $1233.99/month and $220,318.07 over the life of the loan.
With this scenario, the difference between 3.5 and 4.5 percent is actually a bit less than the $90 above, and the overall difference paid is a bit over $14,000.
However, you’ll really enjoy big savings comes when you compare the total cost of both loans.
A 3.5% mortgage at 15 years would save you almost $53,000 compared to a 30-year loan.
A 4.5% mortgage at 15 years would save you over $71,000 compared to a 30-year loan.
How to Get the Best Rate
In a nutshell, you want to make sure:
- Your credit score is as high as you can get it.
- Your credit report has as little negative and as much positive information as possible.
- Your down payment is as high as you can make it. A 20% down payment will typically net you a lower loan rate than, say, a 3% down payment.
- Your current outstanding debt is as close to zero as you can get it. The less money you have to pay out every month, the less risky you are to a lender.
- You have a long-term, stable job so again, there’s less risk to the lender.
If any of these need to be improved, you’ll want to start at least three—preferably six—months before you start shopping for a loan.
A Point about Points
You may have heard the term “points” or “mortgage points” when loan shopping. Essentially, a point is an amount taken off of your loan (typically 0.125 percent) in exchange for a fee.
So, if you wanted to knock your 4.5% loan down to 4.25% you’d pay, say $2,000 a point (the actual amount could be more or less) or $4000 total.
At first blush, this seems like a good deal, and it is if:
- You actually have several thousand spare dollars that can be spent on points.
- You plan on staying in your home for a couple of decades. If you sell your home after just a few years, you won’t have spent enough time to offset the extra cash payment.
If either of the above isn’t true, then points may not offer the best ROI.
“Close” Can Be Costly
Even fractions of one percent can be costly in the long run so it pays to spend a little more time, or even better, work with a loan professional to secure the best home mortgage rates possible.
Want to learn more about interest rates and home loans? Answer a few questions here, and a home lending expert will contact you!