“As a mortgage originator, I am often asked the same question, “What is your rate?” I always cringe when I hear an originator answer that question.
There is so much more to a mortgage than its rate. You can have almost any rate you want if you are willing to pay for it.
I am a huge proponent of the “No Cost Mortgage.” With every rate you are offered there are corresponding costs. In Indiana, the typical costs involved in taking out a mortgage are about $2,400. These costs are used to pay for necessary components of your mortgage, such as, an appraisal, title work, a credit report, the closing fee, the recording of a mortgage, the underwriting fee etc.
This is where mortgages get interesting, at least for math geeks like me. You can pay points to lower the rate, 1-point equals 1% of your mortgage balance. This is known as buying down your interest rate. What often is overlooked is the opposite option, which would be selecting a higher rate and in return receive a cash credit (points) that are used to pay a portion, or all, of your closing costs.
Let’s review the options when refinancing a $240,000 mortgage. Let’s say the going 30-year fixed rate is 6.0%, that rate would come with the standard $2,400 in closing costs. The principal and interest payment would be $1,438.92. You could choose to pay 1 point, which would make your total mortgage costs $4,800; $2,400 for the point and $2,400 for the standard costs to take out a mortgage. Paying that point would drop the rate from 6.0% to 5.625%, making the principal and interest payment of $1,381.58. Alternatively, you could accept a rate of 6.375%. In return for taking the higher rate, the lender will credit you 1 point, which is $2,400 and would be used to offset your costs at closing, making your refinance 100% free. So, you have the option to choose a 6.375% rate and refinance for free, thus choosing the no cost option. The principal and interest payment at 6.375% would be
$1,497.29.
When analyzing the various mortgage options, I find it helpful to calculate a breakeven point. The breakeven point is the point in time when the savings gained from the lower payment that accompanies the lower rate equals the additional cost paid to get that rate. In our example, when you choose the 6.0% rate rather than the 6.375% rate, your payment is $58.37 lower per month, $1,497.29 less $1,438.92. To achieve this lower payment, you forgo a
$2,400, 1-point credit. Thus, the cost difference is $2,400, $2,400 less $0. To determine the breakeven point, I divide the $58.37 monthly savings into the $2,400 in additional costs and come up with 41. That means it will take 41 months, or almost 3.5 years, to recoup the money you would pay upfront in costs through the lower payment you would receive. A lot can change in 3.5 years.
I am a big proponent of the no cost mortgage. It is an especially appealing option in a downward trending interest rate environment. The most common reason someone might select a no cost loan is that he or she feels that rates will likely be lower at some point in the next few years, making a second refinance fairly likely. A couple other reasons you might consider the no cost refinance would be you might end up moving in the next few years or you might have large expenses, i.e., college costs, home improvements, soon and thus might consider taking cash from your home’s equity. Whether or not to pay costs is an important part of your decision when you are refinancing.
The no cost mortgage makes your mortgage a liquid financial instrument. As first mortgage money is often the cheapest money, or lowest interest rate, available, it could be wise to keep that mortgage liquid by not paying a bunch or any of the costs for that mortgage. If you pay costs, your mortgage is still liquid, but you are less likely to consider restructuring your debt / refinancing if you have already paid a bunch of money the first time you did your mortgage.
The no cost mortgage is more beneficial the higher the loan balance, as most of the required costs are fixed, whereas points are a percentage of the loan’s balance and thus variable. Yet, a no cost mortgage will often make sense even with smaller loan amounts.”
Mike Morin – Healy Mortgage Originator