You have a pile of mortgage interest rate quotes and are ready to choose a home loan. The interest rates and lender fees are all over the map--which loan should you choose?
The Mortgage with the Lowest APR
Annual percentage rate (APR) calculations are useful to see how much bang for your buck you get by paying extra fees or points in exchange for a lower interest rate. But you may be doing yourself a disservice by arbitrarily selecting the loan with the lowest APR. For instance, compare these two $400,000 mortgage quotes--the first has a 5% interest rate and costs one percent ($4,000) plus $2,000 in other closing costs. Its APR is 5.13%. A second loan carries an interest rate of 4.75%, costs 3.5 points plus $2,000 in fees and has an APR of 5.09%. That's the better deal, right? Not necessarily, for a couple of reasons.
- Your APR depends on your time frame. Upfront costs are spread over the life of the loan for the purposes of calculating your APR. But what if you don't keep your loan for thirty years? What if you sell or refinance in five years? In that case, the loan with the higher upfront costs becomes pretty expensive--the first loan's APR increases to 5.364% and the second loan's APR shoots up to 6.374%! In that case, if you could find a no-cost purchase or mortgage refinance at 5.25%, the loan with the higher interest rate becomes your best deal.
- Money paid upfront is money that can't be spent on other things. Perhaps you could earn more by investing the 3.5 points, which is $14,000 on a $400,000 loan, than you'd save with a slightly lower rate. Even more importantly, if forking out that extra $14,000 means emptying your emergency fund, you could be putting your home at risk by buying a lower mortgage rate.
The Thirty-year Home Loan with the Lowest Interest Rate
Unless you plan on keeping your home and your mortgage for decades, you could be throwing your money away by shopping for the lowest thirty-year fixed rate when even an average 5/1 hybrid mortgage carries a rate a full percent lower. The best deal on the wrong product isn't the best deal.
Choosing a mortgage isn't a point and shoot decision. Carefully consider the strength of your assets, the stability of your income, and your plans for the next five and ten years before picking your next home loan.