Selecting your lender and choosing the terms of your mortgage is an intricate and important process.
Borrowers often have the option to pay down points or choose an adjustable rate mortgage, decisions that can make sense for one individual but not another. Before a customer can make a savvy decision, it is important to answer a few basic questions, such as:
How long do I plan on owning this home?
Do I have liquid funds available to cover closing costs?
Do I want to pay funds up front for a lower life of loan interest rate?
Would a seller funded buydown that temporarily reduces my monthly payment be beneficial?
Knowing these answers will guide any consumer on navigating the below factors that will affect their mortgage interest rate.
Paying points on a mortgage is a strategy that allows you to lower your interest rate by making an upfront payment to your lender. Each point typically costs 1% of your mortgage loan amount and can reduce your interest rate by a certain percentage, often 0.25% per point, although this can vary depending on the lender and the current market conditions.
Points: You have the option to pay for points when you first take out your mortgage. The more points you pay, the lower your interest rate will be.
Lower Interest Rate: Each point you pay typically reduces your interest rate over the life of the loan. For example, if you're taking out a 30-year fixed-rate mortgage and you pay one point, it might lower your interest rate from 4.5% to 4.25%.
Upfront Cost: The cost of the points is an upfront expense that you'll need to pay at the time of closing when you finalize your mortgage. Each point costs 1% of the loan amount, so if you're borrowing $200,000 and you buy one point, it will cost you $2,000.
Long-Term Savings: By paying points and reducing your interest rate, you can save money over the life of the loan. This can be especially beneficial if you plan to stay in your home for a long time. The amount you save on interest over the years can offset the initial upfront cost of the points.
Premium pricing on a mortgage loan for closing costs refers to a strategy where a borrower pays a higher interest rate on their mortgage in exchange for the lender covering some or all of the borrower's closing costs.
Interest Rate Increase: When you take out a mortgage, the interest rate on the loan is a critical factor in determining your monthly mortgage payments. Lenders offer borrowers the option to increase the interest rate slightly, typically in increments of 0.125% or 0.25%, in exchange for covering some of the closing costs.
Lower Upfront Costs: By choosing premium pricing, borrowers can reduce the amount of money they need to pay upfront for closing costs, which can include expenses such as appraisal fees, title insurance, underwriting fees, and more. Instead of paying these costs out of pocket, the borrower finances them through a higher interest rate.
Monthly Payment Impact: The trade-off for lower upfront costs is that the borrower's monthly mortgage payments will be slightly higher due to the increased interest rate. This can impact the overall cost of the loan over its term, potentially resulting in higher total interest payments over the life of the mortgage.
Duration of Premium Pricing: Premium pricing typically lasts for the life of the loan, so the borrower will pay the increased interest rate for as long as they hold the mortgage.
A temporary buydown on a mortgage is a financial arrangement where a borrower or seller pays additional funds upfront to reduce the initial interest rate on their mortgage for a certain period of time. The goal of a temporary buydown is to make homeownership more affordable during the early years of the mortgage, especially when the borrower expects to have lower income initially or needs to reduce their monthly payments.
Upfront Payment: The borrower or seller pays a lump sum to the lender or mortgage broker at the time of closing the loan. This upfront payment is often referred to as "buydown points."
Interest Rate Reduction: The lender uses the upfront payment to "buy down" or reduce the interest rate on the mortgage. The interest rate reduction is typically applied for a set period, such as the first one to three years of the loan.
Gradual Increase: After the initial lower interest rate period ends, the interest rate gradually increases over time until it reaches the level it would have been without the buydown.
A small difference in interest rate can add up over time, so it is best to compare options and shop. A mortgage rate also depends on the type of loan, term, and individual creditworthiness. It is highly advisable to consult with a financial advisor or licensed loan officer who can help navigate these options and choose the right interest rate.
If a borrower has good credit, intends to stay in their home for a long period of time and expects interest rates to remain at around the same levels, paying down points and choosing the lowest interest rate is likely the best option. This will cost the borrower the most upfront, however over a long duration will save the borrower money. While ARMs may be attractive, the borrower should carefully consider the risk this poses, as the borrower in this situation is likely to face a fluctuation in their monthly payment.
If a borrower is likely to move in a few years, significantly improve their credit score, or expects interest rates to decline, minimizing upfront costs is likely the best path forward. This is because the borrower will likely payoff their mortgage or refinance at a lower rate. ARMs may pose less risk to this borrower, as they likely will find it advantageous to payoff their mortgage within a few years, before their interest rate adjusts.
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