by Nancy Osborne, COO of ERATE®
Finding the best mortgage rate may not be as easy as simply identifying the lowest interest rate available. The criteria a mortgage shopper should apply must begin with the question of how long they plan to hold onto the mortgage and retain ownership of the property. There is no reason to consider the option of paying points and fees to buy down the interest rate when a borrower does not plan to own the property long enough to re-coup (or at least break even) on the closing costs. The second criteria that should be used in determining whether to buy the interest rate down by paying point and fees, is whether a borrower is refinancing or purchasing the property in question. When refinancing, points and fees have a different tax treatment than if the transaction involves a purchase. Deducting points and fees typically has a more favorable tax treatment in a purchase transaction rather than in refinancing when the deduction of points is normally amortized over the life of the loan and not deducted in the year they are paid as is typically the case in a purchase.
Another criteria frequently used to determine the best mortgage rate is APR or the Annual Percentage Rate. The purpose of the APR is to give the mortgage consumer a basis of comparing several loans by examining the total cost of the loan, including some specific costs, over a period of time by reflecting some of those costs in the interest rate (30 year mortgage rates). The problem with the APR is that it is not required to be calculated the same way across the board, for instance one area were lenders can differ dramatically when it comes to quoting APR, is the number of days of pro-rated interest they use when arriving at their APR calculation. Pro-rated interest is the number of days remaining within a month that you will pay interest after your new loan closes, for example if your loan should close on the 15th of the month then you would have 15 days (or 16 if the month has 31 days) interest remaining to pay on the new loan. The problem with lenders including the pro-rated interest in the APR is that there is no uniform requirement for how it is quoted. Some lenders use 15 days in their calculation and some may use 30 days, a few may even use zero days of pro-rated interest in their APR calculation so it will appear (somewhat deceptively) to be the lowest among their competitors.
What type of loan would be best mortgage for you? With so many sub-prime borrowers having been burned recently by adjustable rate mortgages, ARMs are being avoided like the plague in this new post-mortgage meltdown era. It's unfortunate that all adjustable loans are being written off by many consumers and are now being presented in the same negative light. In fact, given the right circumstances, an adjustable loan can be a wonderful tool for managing one's personal cash flow if a borrower is both responsible and educated in maintaining their own finances. Risk tolerance, along with personal confidence and skill, in controlling one's finances is critical in determining whether an ARM might be right for a particular borrower. ARMs can also be useful for borrowers who have a short term ownership horizon, perhaps of less than 3-5 years. Of course given the soft real estate market currently experienced throughout the country, buying a home with such a short term time horizon would likely be a foolish strategy. Fixed rate mortgages are always a safe bet and in many cases borrowers are better off taking a 30 year term versus the shorter 15 year term. Borrowers opting for the 30 year can always make additional payments to shorten the term of the loan (assuming they take a recommended no prepayment penalty loan), this way they remain in control of managing their mortgage payment and cash flow. A 15 year mortgage can be a terrific, less costly option for the more mature borrower who does not have as many competing demands for their cash (i.e. saving for retirement, kid's college education, etc.).
As you have now seen, determining what the best mortgage rate for you may be is not as simple as it sounds. There are many considerations to take into account and the key to making accurate loan comparisons is to be certain you are truly comparing loans on an apples-to-apples basis and not looking at two loans that have completely different rate and yield equivalencies.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.