Contrary to popular belief, focusing on the interest rate on a mortgage is not the right choice. There are other factors to a mortgage payment that make it affordable. You must look not only at your current affordability, but over the life of the loan. Remember, this is a loan you will have for many years. Whether you have a 15, 20, or 30-year term, the fees add up. Just how much do you want to spend on your mortgage over the life of the loan? This is a question you must ask yourself.
Are you Comfortable With the Payment?
This is really the most important question. You make this payment monthly for many years. If it is a payment you cannot afford, you do not belong taking that mortgage. Whether you have a 2% or 5% interest rate really does not matter if you have a hard time writing the check for the payment. Focus on the affordability of the payment. You can do it in an official manner, by figuring out the percentage of your gross monthly income that the mortgage payment takes up or you can just see what you feel comfortable paying. A few questions you should ask yourself include:
- Do you have enough money left over to pay daily living expenses?
- Is your income stable enough to last for the foreseeable future?
- Do you see yourself changing jobs or your income in the future?
The answers to these questions can help you decide what is right. For example, if you know you want to go from two incomes down to one in the future because you want children, taking on a large mortgage payment may not be right. Consider how the payment affects you now and well into the future.
What Will the Loan Cost in the Long Run?
When you apply for a loan, the lender tells you more than the principal and interest on the loan. They let you know how much the loan costs over the long-term. This is called the APR or annual percentage rate. You will also see the mortgage spelled out after you pay interest for the life of the loan. Pay close attention to this number because it is likely thousands of dollars more than what you think you are borrowing. You can use this figure to help determine if the loan is affordable after all. For example, a $100,000 loan at 4.5% for 30 years will cost you $182,407 in principal and interest alone. This does not take into account the closing costs for the loan.
What are the Closing Costs?
The closing costs play a role in the loan’s affordability. You can get a loan with a low interest rate, but if the lender charges obnoxious fees, it overshadows the benefit of the low interest rate. Pay close attention to the Loan Estimate each lender you apply with provides you. This document details the closing costs. You can compare different quotes from each lender to determine the right choice for you. Don’t compare total closing cost, though. Instead, look at each line item. For example, one lender might charge a processing fee, underwriting fee, and document fee. Another might not charge those fees, but lumps everything into an origination fee.
Should Buyers Pay Points?
Paying points is always a controversial topic. You might think you are getting a great deal with a low interest rate, but if you look at the closing costs the lender might be charging several discount points. On a $200,000 loan, this could equal $4,000 or more. If you do not plan to stay in the home for the long-term, it might not make sense to pay the points to get the lower interest rate. You can figure out what makes sense based on how long you think you will stay in the home. Here is an example:
- If you plan to stay in the home for 30 years, it makes sense to pay 2 points to get the interest rate lowered. Because you will pay the interest for the life of the loan, it will only take a few years to make up the $4,000 in points.
- If you know you will move in 5 years, though, it might not make sense. First, you must determine how much you will save each month with the lower interest rate. Then you must figure out how long it will take you to pay off the discount points. If it takes 60 months to pay off the points, you will never reap the benefit of the lower interest rate. In this case, it doesn’t make sense to pay points.
Do you Like the Lender?
Something that has nothing to do with the interest rate is whether you like the lender. Remember, you must deal with them for many years Ask yourself questions, such as:
- Are they accessible?
- Do you like their customer service?
- Do they offer online payments?
- Do they allow bi-weekly payments?
You can determine which of these issues are most important to you. For example, if you don’t think you will make bi-weekly payments, you don’t have to worry about that factor. Customer service and accessibility are important for just about everyone though. You want to feel comfortable with the people who hold the loan that has your house as collateral.
As you can see, interest rates are not the only factor you should concern yourself with when you shop for a mortgage. When you look at each factor that plays a role in your mortgage payment, you can make a more informed decision. The interest rate is one of the last things you should worry about. On a $100,000 loan, a 0.5% increase only amounts to about $25 more per month. But if you end up with a lender you don’t like or you have to pay many points to get the lower rate, it might not be worth it. Look at the big picture before you make any decisions.
