Lowest Interest Rate, Lowest Payment

Will the lowest interest rate always give me the lowest monthly payment?

2 Answers

If you compare apples to apples -- and not to oranges, grapefruit or cantaloupe -- a lower interest rate will always give you a lower mortgage payment. Let me explain what I mean by comparing apples to apples.

First of all, you have to be comparing mortgages with the same mortgage amount. That should be pretty self-explanatory.

Second, you have to be talking about mortgages with the same amortization period. A fifteen-year fixed mortgage with a 6% rate will have a higher payment than a thirty-year fixed mortgage with a 6.25% rate. Go to any online mortgage payment calculator and give it a try.

Third, you have to be talking about the same kind of mortgage. An interest-only mortgage at 6.5% will have a lower payment than a fully amortizing loan.

Last, but not least, for the purpose of this answer, when I talk about "mortgage payment" I mean the money that you send to your lender every month to pay off the loan.
Mortgage insurance may be a factor; conventional mortgage insurance and mortgage insurance for FHA loans have different premiums. You send that money to your lender every month, but it's not something that goes towards paying off your loan. Similarly, if you are looking at two different houses that each cost $100,000 and you planning on putting down 10%, your total payment would be different for each because, in all likelihood, each property has different costs for taxes and insurance.

Hope that helps. Feel free to get in touch if you have any further questions.

As with all things in life - "It depends".  The biggest deciding factor is how long you intend on keeping the home- this should be the biggest deciding factor between one rate or another- a low rate quoted is useless if the upfront costs are high enough to wipe out any savings.

If you intend on selling sooner or later it may be better to accept a slightly higher rate and lower overall upfront cost.

As it pertains to evaluating loan offers- there is usually a relationship between a given interest rate and a cost to get there.  During your evaluation you will discover the final payment will not only be influenced by the rate but the overall costs to get that rate- and how soon the monthly savings pays for iteslf A real world example would be something like this- let's assume the following facts:

1)- you plan on keeping the home for 5 years, until the kids get out of the nest and then you are going to retire and sell the home

  1. you need to borrow $100K

you have two offers from local outfits.

1st offer: total points and fees new loan amount= $105K, Principal and interest payment on 30/fixed = $639.28

2nd offer total points and fees new loan amount= $103K principal and interest payment = $661.12

Net difference - $2k in additional costs nets $21.84 in monthly savings.  So, if you pay an additional $2k up front, they lower the payment $21.84.

Once again, assuming you intend on selling the house by the 5th year (60th payment) your actual balance sheet will look like this

1st offer $2k cost, $21.84 x 60 payments = $1298.40 over the other loan offer.  Subtract $1294.60 from original cost to get rate of $2k = a NET LOSS of $701.60 ** 2nd offer, $21.84 x 60 payments = $1284.40 net additional cost.  So, original loan amount of $#103K + net additional payment of $1298.40 = total adjusted amount borrowed $104298.40. ** You save money going with the higher rate in this instance** Conversely, if you were to keep the home and the intention is to pay it off and retire there then the better loan changes.

That formula is : additional cost / amount of monthly savings = months to pay off additional cost.  So ($2000 / $21.84= 91.56 months) So, pay an additional $2k, save $21.84 monthly and the additional $2k fee is paid off in 91.56 payments, or 7.6 Years.  If you intend on keeping the house permanently you actually save money if you keep the loan over 7.6 years.

Now, the next question you may be thinking is "points, fees, processing, what's the difference between them all?

In a nutshell, the fees are divided into different categories

1- all fees paid to the bank for granting the loan (points, fees, processing, application, anything they declare is paid to them out of the loan directly) Typically under the 1st section of the Good Faith Estimate (section 800) you will find these fees.  ** ** NOTE: things like appraisal fees are typically paid to a 3rd party- the appraiser so that isn't money that the lender gets as a result of you doing the loan - that goes to the appraiser. ** 2)- taxes, insurance or fees to the state paid on behalf of your property (your taxes and insurance owed local govt) These will always be costs paid as long as you own your home- these are mandatory ** 3)- fees paid to 3rd parties responsible for doing due dilligence.  For instance: ** Appraisal (to certify your property does exist and to prove it's value) ** Title Insurance. to provide proof you have the legal right to lien the property- and ** Escrow- a neutral party that does not directly represent either the borrower or the bank that is in charge of giving the banks money to the borrower, and the borrower's signatures to the bank. Categories 2 and 3 above will always be required on every loan so that needs to be noted- without those the lender cannot grant the loan- so those services are ALWAYS required to ensure the lender is following all lending laws.  There is no way to not have those services, but you may be able to get the lender to pay some if not all those costs as well - once again reducing the amount you need to pay or borrow to pay for those mandatory costs.

I typically advise clients to add together all fees they figure are payable to the lender- admin fee, application fee, points, discount points, anything that is paid to the bank for granting the loan when comparing actual costs.  If the fees seem out of line compared to other offers, then you know it's a bad deal.

If the loan offer costs seem reasonable compared to others, and the rate seems in line, then proceed with the comparisons above to determine which one suits your needs best.

Whatever you do, don't fall for anyone pushing "low rate! low rate!' the better question to ask is, "how much for that rate?"

Hope this helps.