Getting a Mortgage? Why You Can't Just Look at Rates

by Maurie Backman | Updated July 19, 2021 - First published on Jan. 24, 2021

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You shouldn't accept an offer for a home loan based on its interest rate alone.

The lower the interest rate you pay on your mortgage, the less expensive your monthly payments will be. And keeping your mortgage rate low means you'll pay less total interest over the life of your loan. But while interest rates are an important factor to look at when deciding whether or not to accept a lender's offer, they're not the only thing to consider.

Don't ignore your closing costs

Getting a mortgage isn't free. Rather, you'll have to pay closing costs to finalize your loan. These include things like origination fees, appraisal fees, recording fees, and title searches.

Closings costs generally amount to 2% to 5% of your loan amount. Clearly, that's a big range. They're also somewhat discretionary. Lenders can't control some of the costs -- for example, the fee to record a mortgage is generally established by local governments and is unavoidable. But others are flexible and negotiable. So, if you're shopping around for a mortgage with different lenders, it's important to compare not just interest rates but also closing costs.

Imagine one lender charges you a lower interest rate than another so you'd pay $20 less per month for your loan. That's a big difference. After all, who wouldn't want to save $240 a year? But what if that same lender with the lower rate also charges an extra $2,000 in closing costs? Suddenly, you're not getting the savings you thought you were. You'd need to make payments for 100 months to break even compared to the offer with no closing costs.

Granted, when you sign a 30-mortgage, you sign up for 360 payments (assuming you don't pay off your home loan early). As such, in this scenario, once you break even after 100 payments, you'd enjoy $20 of savings over the course of 260 payments for a total of $5,200. But that also assumes you don't move or refinance your mortgage during that time. So in this case, you may be better off opting for the loan with the lower closing costs. A lot can happen in the course of 100 months, and you may not even stay in your home long enough to break even.

It pays to negotiate

If you receive an offer for a low interest rate on a mortgage but higher closing costs than what a competing lender is asking for, it never hurts to try to negotiate. If the first lender really wants your business, it may agree to come down on closing costs, especially if you're a strong mortgage candidate with great credit.

That said, some lenders are willing to match each other on rates, so you could always do the opposite, too -- go back to a lender with lower closing costs and ask it to drop its interest rate. There are plenty of options to play around with, but the point is that closing costs should factor into your decision to sign a mortgage just like rates should. Keep that in mind as you submit those home loan applications.

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