If you’re looking for a new home, you’ll probably need a mortgage to finance it (unless you have several hundred thousand dollars in the bank). And it’s always a good idea to shop around for a mortgage rather than accepting the first offer you get.
The reason? Each mortgage lender is unique, so you can find a range of interest rates attached to your mortgage offers.
Now, you can assume that when you compare the offers, it pays to choose the lender that has the lowest interest rate. But here’s why an offer with a higher interest rate might actually be a better bet.
It’s all in the big picture
When you take out a mortgage, it’s not just the interest you have to pay on that loan. You will also have to pay closing costs – the various fees required to finalize a mortgage.
Closing costs often include:
- Application fees
- Loan origination fees
- Expertise fees
- Title search and insurance fees
- Registration fees
Typically, you can expect your closing costs to be 2-5% of your mortgage amount. But that’s a pretty big range.
Suppose you take out a mortgage for $ 300,000. If a lender’s closing costs are 2% of your loan, you’ll spend $ 6,000. But if another lender charges 4%, you’ll spend $ 12,000.
Now you can get a mortgage offer with a low interest rate and low closing costs. But you might also find that the higher an interest rate you are offered, the higher the lender’s closing costs are, and vice versa. And that is exactly why it sometimes pays to accept a mortgage offer with a higher interest rate because that lender can offer more competitive closing costs in return.
When a higher interest rate makes sense
Now you might be thinking: are lower closing costs really worth a higher interest rate? And the answer is they could be.
Suppose a lender offers you a mortgage for $ 300,000 over 30 years at an interest rate of 3.2% with $ 6,000 in closing costs. Meanwhile, another lender offers you the 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 on closing costs but pay $ 33 more per month, you’ll break even in 181 months, or about 15 years. From there, yes you will start losing money with the higher interest rate because you will keep paying $ 33 more each month. But a lot can happen in 15 years. You could move to another house or refinance.
As such, it’s always a good idea to look at closing costs. and interest rate when deciding which mortgage offer to accept. And you shouldn’t be too quick to cancel an offer with a higher interest rate until you’ve assessed the big picture. This is true whether you are applying for a mortgage to buy a home or refinancing an existing loan. If you’re not sure what the best buying option is, use a mortgage calculator to work out the numbers so you come away with the best possible deal.