I posted a guest article on Using APR (Annual Percentage Rate) To Shop For A Mortgage back in November. The gist of that post was that attempting to compare mortgage costs based on APR can be quite deceptive and the author suggested getting a loan estimate in order to fully understand the costs. However, even comparing loan estimates can be a little tricky since you might find yourself comparing loans with two different interest rates in addition to different up front costs. How can you make this simpler?
The first step is to make sure that the loan options you are considering all contain a comprehensive list of all the up front costs. Here is a list of what to look for and I can’t promise you that even this is truly comprehensive:
- Origination charges (a big one)
- Rate lock fee
- Underwriting fee
- Rate buydown points
- Document preparation fee
- Appraisal fee
- Credit report
- Flood determination fee
- Flood coverage
- Tax service
- Tax certification fee
- Title closing protection letter
- Title courier fee
- IL title policy fee
- Lender’s title policy
- Title recording service
- Closing fee
- Recording fee
Some of these fees are just different names for the same thing. Just make sure when getting mortgage estimates that all of them include a comprehensive set of costs. If the interest rates were the same on all the mortgage estimates then you would just choose the one with the lowest up front costs.
But suppose you are quoted different rates in addition to different up front costs? Well, there’s a way to put everyone on a level playing field. First, make sure that none of your quotes include mortgage points (discount points) for buying down (lowering) the rate because that will just lower the quoted rate in exchange for an up front cost. If that’s part of the quote take it out so that you can compare “par” rates. Then, using your lowest quoted par rate as a benchmark, find out what it would cost you to buy down the rates on your other quotes to match that lowest rate and add that cost to your up front costs. Once you have all your quotes at the same rate you can simply choose the mortgage with the lowest total up front costs. Whether or not you actually buy down the rate is a separate decision.
Should You Buy Down Your Mortgage Rate?
Just the other day I analyzed this for my California daughter’s new home purchase. I got 4 quotes from the lender for a sequence of 1/8, 2/8, 3/8, and 1/2 percent buy downs and looked at how long it would take to recoup the points paid with the interest savings. And notice that I intentionally did not look at the reduction in the mortgage payment because that includes principal repayments which are not a cost. While it affects cash flow there is no economic cost to repaying principal.
But there is another wrinkle in this analysis. The pricing on these buy downs are not linear. In other words, each successive 1/8 incremental buy down costs more than the previous one. So you have to look at the marginal cost and the marginal benefit of stepping down the additional 1/8 percent. For example, I didn’t look at the payback on a 1/2 percent buy down. Instead I looked at the payback of the incremental buy down from 3/8 to 1/2 percent. Here is what I found – roughly:
- The payback on the first 1/8 is about 1 year
- The payback on the second 1/8 is about 2 years
- The third takes about 3 years
- The fourth takes about 4 years
So then you have to decide, first, how long are you likely to stay in the home? If you might move within 4 years it probably doesn’t make sense to buy the rate all the way down to 1/2 percent. Then the other consideration is whether or not, in the absence of a buy down, there might be an opportunity to refinance the mortgage at a lower rate down the road. In other words if you buy the rate down by 1/2 percent but rates drop that much within the next year…well…then you would have been better off not buying the rate down that low.
Unfortunately, there is no exact science to deciding how low to go with the buy down. At the end of the day it’s a judgment call informed by the different payback periods for each successive step.
How Good Is The Mortgage Broker?
This entire post assumes you are just shopping for the cheapest mortgage. However, as I’ve pointed out before, that’s not the only consideration in choosing a mortgage lender because competence is also critical. I will tell you that our experience with banks has been pretty consistently bad. They are bureaucratic, rigid, they have limited offerings, and sometimes their people just aren’t that smart. Often you are better off going with a mortgage broker who has the flexibility to look across lenders and mortgage offerings to find you the best alternative for your situation. Ask your realtor for a recommendation. They have the experience to know who’s good and who’s a clown and, no, they don’t get a kickback from the lender. That’s illegal.
#HomeBuying #Mortgages #MortgageShopping
Gary Lucido is the President of Lucid Realty, the Chicago area’s full service real estate brokerage that offers home buyer rebates and discount commissions. If you want to keep up to date on the Chicago real estate market or get an insider’s view of the seamy underbelly of the real estate industry you can Subscribe to Getting Real by Email using the form below. Please be sure to verify your email address when you receive the verification notice.