Does Your Interest Rate Matter?

So, now that 30-year fixed rates are cresting 6.5%, it’s time to ask a question: how important is your interest rate on your mortgage?

There are several answers to this question.  You’re instantly thinking one of them.  Let’s take them in turn, then, shall we?

What most people are thinking: the rate is critical.  Nothing matters more than the interest rate.  I once had a client that got a 5% fixed rate on his 30-year mortgage.  What was unusual about this is that he was willing to pay over $15,000 in discount points to get it.  That rate was about 3 points below par (the rate at which the broker gets paid nothing by the wholesale lender).  Was this a good idea?  We’ll explore that.

What some people are thinking: the rate is important, but it has to be balanced by closing costs.  Some people don’t know this (if you’re one of them, you haven’t been paying attention to this blog), but your closing costs and your interest rate are absolutely inextricably linked.  Get a high enough rate, and you could have no closing costs at all (I did several of those kinds of “no cost” refinances a couple of years ago).  Get a low enough rate, and your closing costs could be astronomical (see example above).  Your closing costs will generally average about 3% of your loan amount.  If you get better than that, good for you, but understand that your rate will reflect it – or someone cut you a super deal.

A note about super deals: I understand that the cheapest wireless router in town is being sold at Wal-Mart.  I don’t buy computer equipment from Wal-Mart, however.  Or garden supplies.  Or, frankly, much else that is truly important to me.  Lots of people want a cut-rate mortgage with no closing costs and a rock-bottom rate.  These same people would never shop at Deseret Industries (the DI, to us in Utah) or the Salvation Army for clothes, though.  They are willing to pay Nordstrom $125 for a couple pair of jeans, but when someone is helping them borrow $350,000, they want DI prices.  Which is sillier – expecting top-quality clothes from a discount used-clothing retailer or expecting that the same rules that apply to clothes won’t apply to mortgages?

What practically nobody is thinking: the interest rate makes almost no difference at all.  All that matters is the payment.  Now, there are some people that think this when they should be thinking one or the other above, but there are indeed some people that think the foregoing and are perfectly correct.  We did a loan recently for a builder that would be holding construction financing for only a few months while he built several houses on some lots he wanted to buy.  The lots were going to appreciate by 100% themselves, and the houses would sell for roughly 20% over what it cost to build them.  He told me his rate made no difference as long as he got the loans in a week.  Happy to oblige.  He is selling the houses now and will make about $180,000 net profit from the operation.  He couldn’t tell you within two points what his rate is, and I’m not sure I could, either.  Why should we care?

The question really is not “which of these are you thinking” but “which of these things should you be thinking in your situation?”  Guess what?  I don’t know.  I won’t know until about a half hour after we sit down and start discussing your objectives and your current position.  I likely won’t be sure even then, but I’ll have a pretty good guess.  How can you figure this out yourself?  Well, I recommend getting a mortgage license and spending six months or so getting to know lenders and programs.  I have said many times that this business is not rocket science.  It is, however, math intensive and very knowledge-based.  In other words, what you don’t know can hurt you very badly and for years.

Tomorrow: a loan that you never heard of before that could change the way you think about interest rates forever.

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