Should you pay points to get a lower interest rate?
The most common condition on any mortgage is “points.” A point is 1% of the balance of the mortgage. So on a $200,000 mortgage a point is $2,000.
- Brokers like points because that’s how they often get paid.
- Banks like points because they are like paying interest in advance. If you sell the house and pay off the loan, they already have some of their interest.
What a point is worth:
Banks will often give better mortgage rates if you pay points, but unless you are sure you are going to be in the house for ten years or more, it is usually to your advantage to get a loan with no points.
The rule of thumb is that if you pay one point, the interest rate should be at least a quarter of a percentage point lower if you want to “break even.” On a $200,000 mortgage a quarter point will save you $30 a month. That means it will take about three years to get your money back on one point. If you added the $2,000 to your mortgage your savings will be offset by the extra amount it takes to cover the higher mortgage. My estimate is that if you sell or refinance in less than seven years, this is probably not a good deal. Take the higher interest rate.
What are the prepayment penalties?
Every mortgage has prepayment penalties. That is, if you sell your house or refinance during the penalty period you can’t just pay off the loan balance. You also have to pay these penalties, which can be huge -- as much as tens of thousands of dollars over and above the mortgage balance. I have seen a prepayment penalty of $15,000 on a mortgage of only $150,000.
Many states have laws limiting the prepayment penalty period, but so-called “national banks” can usually ignore state laws if they are regulated by the Office of the Controller of the Currency. So the only thing for you to do is find out what the penalties are before you sign for a loan and decide whether or not they matter to you. Some lenders impose periods of five years or more for either resale or refinance. More reasonable penalty periods are one year for sale (if you close a sales after a year has passed, there is no penalty) and three years for refinancing.
Do you mind if your loan is sold?
Mortgage loans are traded like cards today. You may get your loan from one bank, and within 90 days, another bank owns it. I had a mortgage loan that went through three lenders in two years. That meant new paperwork for me every time. Pain in the neck.
Your lender is required to tell you whether or not they resell loans and what percent are typically resold. For my last two mortgages I chose local banks which had not resold any mortgages in the recent past, and neither of them sold mine.
Do you need a “portfolio loan”.
If your mortgage lender wants to sell a loan, it has to conform to certain standards. For example, the borrower’s income and loan payment “ratios” have to be within certain bounds. But if they keep the loan for their own institution, they can pretty much make their own rules. They often call these loans “portfolio loans” as they are kept in the portfolio of the lending institution.
If there is anything unusual about your situation, you will need a portfolio loan.
Are you a U.S. citizen?
Loans sold into the national markets must be made to citizens. If you are not a citizen you will have a problem. The fact is that most mortgage brokers allow you to check off “yes” to the citizenship question, whatever the case. This is almost never caught and the loans go through without a hitch.
However, if anything goes wrong (too many late payments for example) the lender may check, and if the answer to this question is found to be incorrect, they can label the loan as fraudulently obtained and force you to pay it off now. Good luck getting another loan to replace it.
Some banks are willing to loan to non-citizens with federal tax ID numbers. They keep these loans in their portfolios. This is not that uncommon (foreigners buy second homes in the U.S. with mortgages) and perfectly legal, but it is may be hard to find a bank that will do it.
However, if you are not a citizen, it is worth looking around for a mortgage that is legal.
If you can afford to pay biweekly you can save big bucks.
Normally mortgage payments are made monthly, but many lenders offer biweekly payment options. In this case, one half of the monthly payment is usually deducted automatically from your checking account every other week, which means 26 payments a year, or the equivalent of 13 monthly payments. This is relatively painless since most of us think of a month as four weeks anyway, and we often have biweekly pay periods, but it can save you some big bucks.
Taking a 30-year, $100,000 mortgage at 6.25%, monthly payments would be $615.72. Biweekly payments would be $307.86. Over 30 years, total interest if you paid monthly would be $121,658 -- more than the original amount of the loan. With biweekly payments, the mortgage would be paid off 24.3 years, and you would save $27,027 in interest. And if the loan you took was $200,000 you would save twice as much.
The savings are not as dramatic for shorter periods of time, but they are still significant.
Shorter loans also save big bucks with less commitment.
Looking at that same $100,000, 30-year loan at 6.25%, we can see quite dramatically that paying it off in 20 years will save a huge amount of money -- if you can afford the higher payment.
The 30-year loan has a monthly payment of $615.72 and over 30 years you will pay $121,658 in interest.
The same $100,000 loan at 6.25% set up for 20 years would have a monthly payment of $857.42 and total interest payments of only $54,336. That’s a total savings of almost $70,000!
If you are not sure you can afford the higher payment, you do not have to take any risk -- if you stay on top of things. It is always OK to make small additional payments to principal in addition to what is required.
So what you can do, is set up a 30 year mortgage, but every month send them a check for $850 (or some lesser amount), marking the extra for principal payment. Then if there is a month -- or multiple months -- when you do not have the extra money, just don’t send it. If you had a 20-year mortgage they would be after you for not paying the full amount. But when you do it voluntarily on a 30-year mortgage, there is no penalty for not sending the money in any month or months.
If you make the higher payment faithfully, you will get all the savings you would have gotten from a 20-year mortgage, with less risk of setting off “late fees.”
Be sure to check your local banks.
The big companies spend all the marketing bucks, and the big banks get the vast bulk of mortgage loans. Mortgage brokers work with big banks and lenders most of the time. So smaller local banks are often left out of the picture. But they have certain advantages over big banks.
- They are usually subject to state, not federal regulation. Most of the time (not all) your state will have regulations that are stricter and more in your favor than the national banks regulated by the Office of the Controller of the Currency.
- They are staffed by people in your community who may be your friends or neighbors. When you have a problem you go to the branch and talk to the manager. This person will be far more anxious to straighten out the problem than somebody at a call center that might even be in India.
- The local bank is far less likely to sell your mortgage into the national markets. They usually service their own mortgages. Ask them if that is their policy. And they will be far less likely to foreclose should anything go wrong. They almost always hate to foreclose on their neighbors and will do whatever they can to avoid it.
Even interest rates at local banks can be quite competitive. You should make sure you compare them before going national.
The main problem with local banks is that they don’t usually get involved with the higher risk mortgages. They do not lend to “sub-prime” risks and they do not usually make loans to people with little or no equity in the house once the loan is made. But if your credit is good and you have a decent down payment, or some reasonable equity in your house, your local banks could be your best bet.
An Alternative Resource:
For our visitors from the UK, SecuredLoansCompared.com helps you choose the most suitable Home Mortgage refinance rate.