One of the most common mistakes I see borrowers make is comparing mortgages based solely on the interest rate.
The lowest mortgage rate is not necessarily the best mortgage deal.
I've been helping homebuyers and homeowners with mortgage financing since 1999, and I believe you should understand not only the interest rate you're receiving, but what you're paying to obtain that rate.
Interest rate, discount points, lender credits, closing costs and loan term all work together.
My job is to show you those numbers clearly so you can make an informed decision.
— John Madden
Owner, Capital Funding Mortgage Associates
Mortgage Professional Since 1999 | NMLS #960139
There isn't one mortgage rate that applies to every borrower.
Mortgage pricing can be affected by a number of factors, including:
That's why seeing a mortgage rate advertised online doesn't necessarily tell you what your mortgage rate will be—or what it will cost to obtain it.
Your interest rate is used to calculate the interest charged on your mortgage and your scheduled principal-and-interest payment.
APR, or Annual Percentage Rate, attempts to incorporate certain finance charges into a standardized annualized measure.
APR can be useful when comparing similar loans, but I don't believe borrowers should make a mortgage decision based solely on APR either.
Why?
Because APR depends on assumptions about how long the mortgage remains outstanding and which charges are included in the calculation.
I prefer to show borrowers the actual numbers:
Interest Rate
Monthly Payment
Points
Closing Costs
Lender Credits
Cash Required at Closing
Break-Even Period
Then you can evaluate what you're actually receiving.
A discount point is an upfront charge paid in exchange for a particular mortgage interest rate.
One point equals 1% of the loan amount.
On a $400,000 mortgage:
1 point = $4,000
On a $600,000 mortgage:
1 point = $6,000
Paying points may allow you to obtain a lower interest rate.
But that does not automatically mean paying points is a good financial decision.
The real question is:
Suppose you have two choices.
Option A
Higher interest rate
No discount points
Option B
Lower interest rate
$4,000 in additional points
Suppose Option B saves you $80 per month.
The simple break-even calculation is:
$4,000 ÷ $80 = 50 months
It takes approximately 50 months—or a little over four years—to recover the additional $4,000 through monthly payment savings.
Now the important question becomes:
How long do you reasonably expect to keep this mortgage?
If you expect to sell the home or refinance before reaching the break-even point, paying those points may not make financial sense.
If you expect to keep the mortgage well beyond the break-even point, the lower-rate option may deserve serious consideration.
This is why I don't believe in automatically recommending the lowest available interest rate.
I want to know what it costs to get there.
Mortgage pricing can also work in the opposite direction.
Instead of paying additional money for a lower rate, you may be able to select a somewhat higher interest rate in exchange for a lender credit.
That credit can potentially be applied toward eligible closing costs.
This can be useful for borrowers who would rather minimize the amount of cash required at closing.
Again, neither structure is automatically better.
The question is whether the additional monthly payment associated with the higher rate is reasonable compared with the amount of money you're saving upfront.
I think this term causes considerable confusion.
A zero-closing-cost mortgage doesn't mean the costs magically disappear.
Generally, lender credits are used to offset eligible closing costs.
In exchange, the borrower will typically accept a higher interest rate than would otherwise be available without the lender credit.
This can sometimes make excellent financial sense.
For example, a homeowner refinancing may not want to spend several thousand dollars upfront to obtain a mortgage they might refinance again if rates decline.
Likewise, a buyer may prefer to preserve cash after purchasing a home.
The important thing is to compare:
Rate with costs
versus
Rate with lender credit
and determine which structure fits your circumstances.
This is another area where I see a lot of confusion.
Not everything listed under “Cash to Close” is actually a closing cost.
There are generally several categories of money involved in a mortgage transaction.
These can include items such as:
These may include:
If your mortgage has an escrow account, the lender may collect money at closing to establish reserves for future:
These amounts are collected so the lender can pay those bills when they become due.
I don't consider prepaid expenses and escrow deposits the same thing as the actual cost of obtaining the mortgage.
That's an important distinction when comparing two mortgage quotes.
Imagine two lenders give you estimates showing:
Lender A: $14,000 cash to close
Lender B: $11,000 cash to close
It would be easy to conclude that Lender B is $3,000 cheaper.
But that may not be true.
One estimate might include a larger initial escrow deposit.
One could use a different property-tax estimate.
One could include more prepaid interest because of an assumed closing date.
Those differences don't necessarily mean one lender's mortgage costs $3,000 more.
To compare the offers correctly, you need to separate:
actual loan/closing costs
from
prepaid expenses and escrow funding.
This is something I'm happy to do with clients when they receive competing Loan Estimates.
When comparing mortgage offers, I recommend putting them side-by-side and asking:
A different loan amount can make almost every other number look different.
If not, determine what you're paying or receiving for the difference.
Look carefully at the points and lender charges.
A lender credit can materially reduce actual closing costs.
Focus especially on costs that differ because of the lender or rate selection.
Title, taxes, insurance and escrow estimates can sometimes differ even though the eventual actual charges may be similar.
A quote for a locked interest rate isn't necessarily comparable to an unlocked estimate.
Make sure you're comparing the same loan amount and loan term.
This is the question borrowers sometimes forget to ask.
Don't just ask, “What's your rate?”
Ask:
“What's the rate, and what does it cost me to get that rate?”
Mortgage lenders don't all have identical pricing.
Different lenders can have different:
Capital Funding Mortgage is an independent mortgage broker, which means we aren't limited to the mortgage products and pricing of one bank.
We can evaluate options from multiple wholesale lenders.
That doesn't mean one lender will always be best for every borrower.
It means we have the ability to compare.
No.
Just as I wouldn't automatically choose the lowest rate, I wouldn't automatically choose the lowest closing costs.
Suppose one option provides a lender credit that eliminates $5,000 of costs but increases the monthly payment by $150.
The simple break-even calculation is:
$5,000 ÷ $150 = approximately 33 months
If you expect to keep the mortgage substantially longer than that, paying the costs upfront for the lower rate may be preferable.
If you expect to refinance or sell before then, taking the credit may make more sense.
Again, the right answer depends upon your expected time horizon.
When buying a home, you have several competing demands for your cash.
You may need money for:
Sometimes paying thousands of additional dollars upfront to obtain a slightly lower interest rate is worthwhile.
Other times, keeping that money available after closing is more valuable.
I'll show you the alternatives.
LEARN ABOUT HOME PURCHASE FINANCING →
Closing-cost analysis is particularly important when refinancing.
If a refinance costs $5,000 and saves $200 per month:
$5,000 ÷ $200 = 25 months
Your simple break-even period is approximately 25 months.
But I also want to consider:
That's why I don't believe in rules such as:
“You should refinance whenever the rate drops 1%.”
The numbers matter more than an arbitrary percentage.
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Suppose you've already paid eight years on a 30-year mortgage.
You refinance the remaining balance into a new 30-year mortgage.
Your monthly payment might decrease substantially.
But you've also extended the repayment period.
That doesn't necessarily make the refinance bad—but it means the monthly payment alone doesn't tell the entire story.
I want clients to understand how the new mortgage affects:
Payment
Interest
Principal reduction
Remaining term
Total borrowing cost
This becomes especially important when comparing a new 30-year mortgage with a shorter-term option such as a 15-year mortgage.
After more than 25 years in the mortgage business, my approach is straightforward:
I don't believe borrowers should be sold an interest rate.
They should be shown their choices.
If one rate requires points and another provides a lender credit, I'll explain both.
If paying additional costs produces a reasonable break-even period, we'll discuss it.
If a zero-closing-cost structure appears more appropriate, we'll discuss that too.
The goal isn't to produce the lowest number next to the word “Rate.”
The goal is to structure a mortgage that makes financial sense for the borrower.
Before choosing a mortgage, ask:
What is the interest rate?
Is the rate locked?
How long is the rate lock?
Am I paying discount points?
Are there lender credits?
What are the actual lender-related closing costs?
Which amounts are prepaid expenses or escrow deposits?
What is my monthly principal-and-interest payment?
What would the rate be with fewer or no points?
What would the rate be if I wanted a lender credit toward closing costs?
A good mortgage professional should be comfortable answering all of those questions.
If you've received a Loan Estimate or mortgage quote from another lender, I'm happy to compare it with you.
You don't have to guess which numbers matter.
We'll look at the rate, points, lender credits, actual closing costs, monthly payment and break-even period so you can understand the real difference between the options.
Sometimes our option will be better.
Sometimes another quote may be competitive.
Either way, you should understand the numbers before making the decision.
Capital Funding Mortgage Associates is an independent mortgage broker based in Newtown, Bucks County, Pennsylvania, serving homebuyers and homeowners throughout Pennsylvania and New Jersey.
Whether you're purchasing a home or considering refinancing, I'm happy to discuss the available rate-and-cost options with you.
You don't need to apply for a mortgage just to ask me a question.
Owner, Capital Funding Mortgage Associates
Mortgage Professional Since 1999
NMLS #960139
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CONTACT JOHN → 215 601 6724
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John Madden is the owner of Capital Funding Mortgage Associates, an independent mortgage broker based in Newtown, Bucks County, Pennsylvania. John has been helping homebuyers and homeowners with mortgage financing since 1999 and serves clients throughout Pennsylvania and New Jersey.
Learn More About John Madden →
Mortgage rates, programs, pricing, lender credits and guidelines are subject to change and borrower qualification. Examples on this page are illustrative only and are not mortgage quotes or commitments to lend.
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