Please, don’t shop for the lowest rate.
If you want to save yourself thousands of dollars please take the oath with me right now “I will not shop for the lowest interest rate.” What you say! I must be just another mortgage broker who thinks you’re stupid. Or am I? Those of you that have read my blog blownmortgage.com probably are confident in saying that I am not just another mortgage broker spewing out information to sustain the status quo and my paycheck. So why would I tell you to do something that seems so far out-of-whack with your best interest? For precisely this reason: by shopping for the lowest mortgage interest rate you play right in to the hands of unscrupulous mortgage originators and you can wind up spending thousands of dollars unnecessarily.
Why is rate so important to you in the first place? Is it because you really know it to be better for your family and situation? NO! You get excited because of one thing: PRIDE. Pride is an emotion so powerful that humans will do incredibly stupid things in its name. One of those stupid things is shopping for the lowest interest rate on your mortgage. It isn’t your fault you are wired that way. Back when our cavemen ancestors were out hunting, the man who dragged home the largest beast was proclaimed the hero. It’s the same thing today; you stand around your grill and talk about interest rates and who is the hero? The one with the lowest rate! You can feel the pride right now: imagine your best friends and neighbors ooohing and aaahhhing while they marvel at your ability to take on the savage mortgage broker-beast and prevail with an unbelievable interest rate.
You’re nodding right now-you love being the hero. But wake up junior, pride is killing you and your pocketbook. Here’s why shopping for the lowest interest rate is a recipe for disaster and could cost you thousands of real dollars:
- Honest people don’t lie (it’s what makes them honest). They tell you a realistic interest rate and fully disclose closing costs for your transaction. This makes them unattractive and overpriced. Why?
- Because of the liars. Liars lie. And our industry is loaded with them. They tell you unrealistic interest rates and don’t disclose any fees. This makes them attractive and under priced – in other words – a bargain.
- Loans either have a great rate and standard closing costs, or a not-so-great rate and very low or zero closing costs. You never get both, ever.
- If you are enticed by the best (too-good-to-be-true, lowest rate, lowest cost) deal; you’ve CHOSEN to work with one of the biggest scumbags out there – a lying mortgage originator.
What this means in terms of real dollars out of your pocket:
- Interest rates are “sold” to mortgage originators to sell to you. Originators have three choices; they can either (1) sell you the rate that the bank is charging (PAR) or (2) they can sell you a rate higher than what the bank is charging (above PAR) and make Ã¢??rebateÃ¢?? from the bank or (3) they can sell you a rate less than the bank is charging (below PAR) and charge you the difference in closing costs.
- When you tell an originator you want – the lowest rate out there – and you inform them that you are “shopping around” the smart originator is simply going to undercut the competition by selling you an interest rate below par and charging you the difference. Let’s look at how this works:
This is a portion of a traditional rate sheet that loan originators will use to quote interest rates based on the information that you provide them in your loan interview. These rates are NOT accurate, they are just a sample that I am using to illustrate this point.
A couple of points. The left column is the rate column. These are the rates that the loan officer has to choose from this particular bank. The 14 Day column is the price for the rate on a 14 Day rate lock also known as a short lock. The 30 Day column is the price for the rate on a 30 Day rate lock. The price on a longer lock is always worse because banks have to factor in the uncertainty of the market when offering a lock for an extended period of time.
NOTE: A 30 Day lock should be plenty of time to complete a refinance transaction. Rhonda Porter always quotes 45 Day locks in her Friday rate posts on Rain City Guide, which tend to be more applicable to purchase transactions.
So back to our scenario where you’ve told the originator “I’m shopping for the lowest rate out there.” (or something similar) The originator looks at his rate sheet and says “What’s the lowest rate I can get this customer?” Looking at the sheet you see in this example it is 5.75% on a 30 year fixed loan. So the originator tells you over the phone “The best I can get you is a 5.75%.”
You think to yourself “Wow! That is an amazing rate! I’ve found a winner here. Everyone else is quoting me 6.125%, maybe 6% at best! This is the guy I want to work with.”
And so you tell everyone else you’ve been talking to during your shopping “Thanks but no thanks, I’ve got a guy that will get me 5.75%” and you commit to working with that originator.
At this point you’re still asking “Where is this costing me money?” Let’s look at the 30 Day lock column in the graphic for 5.75% you’ll see that there is the number 1.500. That means in order to get that rate the originator has to pay the bank 1.5 points to secure that rate. On a $250,000 loan 1.5 points is $3,750. Where is that money going to come from? You guessed it! The originator is going to charge YOU 1.5 “discount” points in order to secure that low rate. Hey that’s what you wanted, right?
Those 1.5 discount points are ON TOP of the “origination” points the originator is going to charge you for their services. These could range anywhere from 1 to 4 points. Let’s assume they are going to charge you 1.5 origination points to complete the loan. You are now paying $7,500 (at least) in closing costs (not including junk fees, title, escrow, insurance, and everything else that varies depending on your situation/state you live in, etc.) for the privilege of having the 5.75%.
Now let’s look at what that extra $3,750 bought you. If you had taken the rate of 6.125% then you would not have been charged discount points. Because the bank is not charging for the rate of 6.125%, the bank is actually giving .25% points for the 6.125% rate. YouÃ¢??ll see in the 30 Day column next to 6.125% a -0.250. This means that the bank is paying the originator (via yield spread premium) .25% rebate points. The originator now gets that as part of their compensation.
So now perhaps the originator will only charge you 1.25% (because they are already getting paid .25% from the bank) NOTE: Most originators will still charge you 1.5% on the front and make the extra in the back; because they are commission based and greedy. If you went this route your expenses so far are just $3,125 (plus junk fees, title, escrow, etc.). But let’s say that in this example the mortgage originator is greedy and still charges you 1.5 points or $3,750 for their services.
The question to ask yourself is “Where is my break even point?” At what point does it make sense to pay the extra $3,750 in discount points to get the lowest rate? To do this you need to do some personal forecasting and determine how long you plan on:
1. Staying in the loan
2. Staying in the home
As a general rule, the longer you stay in the loan the more using discount points make sense.
Back to our example:
Using the 5.75% interest rate on our $250,000 mortgage our monthly payments will be approximately $1,459 per month.
Using the 6.125% interest rate our monthly payments will be approximately $1,519 per month. A difference of $60 per month.
Now we take the extra $3,750 we spent up front and divide it by $60 to determine when we break even on that investment. The answer is 62.5 months or 5 years and 2.5 months.
This means that we will not break even on this investment for 5 years! And only then will we start to see a return on the investment in the 63rd month of $60.
If you don’t stay in that loan or in that home for at least that long you will have LOST MONEY by choosing the lowest rate.
Shopping for the lowest rate can end up costing you thousands of dollars because you’ll pay up front discount points to save money that you’ll never even see. In this example if you refinance or sell your home before 5 years it will be a money-losing move. What if you need a bigger house? What if you relocate due to a job change? What if interest rates go down and you want to refinance? If any of these things happens before 5 years you will have tossed a portion of the $3,750 down the drain.
So, the next time you’re standing around the barbecue and some one is bragging about how they got “the lowest rate out there” just chuckle and know that they probably have a long way to before that rate starts to pay off. Feel better about taking the slightly higher rate without any discount points and know that you are saving money should you refinance or sell your home.
If anything in this article was unclear or you would like more information or examples please contact me directly at (949) 859-3045 or email me directly.