by Maurie Backman | April 10, 2021
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A higher interest rate on a home loan isn't always a bad thing.
If you're in the market for a new home, you'll probably need a mortgage to finance it (unless you happen to be sitting on several hundred thousand dollars in the bank). And it's always a good idea to shop around for a mortgage rather than accept the first offer you get.
The reason? Each mortgage lender is unique, so you may find a range of interest rates attached to your home loan offers.
Now, you might assume that when comparing offers, it pays to go with the lender that has the lowest interest rate. But here's why an offer with a higher interest rate could actually be a better bet.
When you take out a mortgage, it's not just interest you're required to pay on that loan. You'll also be on the hook for closing costs -- the various fees required to finalize a mortgage.
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Closing costs often include:
Generally speaking, you can expect your closing costs to total 2% to 5% of your mortgage amount. But that's a pretty big range.
Say you're taking out a $300,000 mortgage. If one lender's closing costs amount to 2% of your loan, you'll spend $6,000. But if another lender charges 4%, you'll spend $12,000.
Now, you may get a mortgage offer that comes with a low interest rate and low closing costs. But you may also find that the lower an interest rate you're offered, the higher that lender's closing costs are, and vice versa. And that's exactly why it sometimes pays to accept a mortgage offer with a higher interest rate -- because that lender may offer more competitive closing costs in exchange.
Now you may be thinking -- are lower closing costs really worth a higher interest rate? And the answer is that they could be.
Say one lender offers you a 30-year, $300,000 mortgage at 3.2% interest with $6,000 in closing costs. Meanwhile, another lender offers you that same loan at 3% interest with $12,000 in closing costs. The difference in monthly payments between the two interest rates is $33.
If you spend $6,000 less in closing costs but pay an extra $33 a month, you'll break even in 181 months, or about 15 years. From there, yes, you will start to lose money with the higher interest rate because you'll continue paying $33 more each month. But a lot can happen in 15 years. You might move to another home, or refinance.
As such, it's always a good idea to look at closing costs and interest rates when deciding which mortgage offer to accept. And you shouldn't be too quick to write off an offer with a higher interest rate until you assess the big picture. This holds true whether you're applying for a mortgage to buy a home or are refinancing an existing loan. If you're not sure what the best call is, use a mortgage calculator to crunch the numbers so you walk away with the best possible deal.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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