How to Compare Mortgage Rates
Comparing mortgage rates is one of the best ways to save money when you get a home loan. Reducing your rate by as little as 0.125% lowers your monthly mortgage payment and can save you thousands of dollars in interest expense over the life of your loan. For example, for a $300,000 30 year fixed rate mortgage, lowering your rate from 4.625% to 4.500% saves you over $8,000 in interest expense over you loan. With mortgages, a small difference in interest rate adds up to a lot of money over time. With a 30 year loan, you make 360 monthly payments. If you lower your loan payment by just $10, you would save $3,600 by the end of your mortgage, which is a significant amount of money.
Comparing mortgage rates is important because it can save you a lot of money but how do you go about doing it? It may seem like an easy exercise -- simply pick the lowest rate -- but there is more to the process than that. There are many factors that you should consider when you compare mortgage rates such as the number of lenders you contact, the type and length of loan, discount points and origination fees as well as other closing costs. It is important that you compare similar loan programs and consider all of the inputs that influence mortgage rate pricing. When you take all these factors into account, the process becomes more than just picking the lowest number. In fact, in some cases selecting the lowest mortgage rate may not always make the most financial sense, especially if it means you pay significantly higher closing costs.
Below, we outline how to compare mortgage rates so you can find the right loan terms. We also identify the other factors that you should consider in addition to the rate itself. Reviewing the points below will help you understand how mortgage rate pricing works and why different loan programs and lenders have different rates. Follow these steps so that you can find the rate, loan and lender that best meet your personal and financial goals.
Determine the Number of Lenders to Compare
There is no magic number for the number of lenders you should compare but studies show that the more lenders you compare, the more money you save. For example, borrowers that compare five lenders save an average of approximately $3,000 over the course of their mortgage as compared to a savings of less than $1,500 for borrowers that compare two lenders. When shopping mortgage rates, we recommend that you compare at least five lenders. Comparing rates for that many lenders requires extra time and effort but finding superior loan terms, including a lower mortgage rate, can save you thousands of dollars.
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Understand How Different Loan Programs Have Different Mortgage Rates
When you shop mortgage rates it is very important that you compare the same type of loan program to ensure that the comparison is meaningful. For example, fixed rate mortgages usually have slightly higher interest rates than adjustable rate mortgage (ARMs) and interest only loans. Fixed rate mortgages, however, are structured differently than these other loan programs and involve less risk for borrowers.
In some cases, lenders may try to entice you with the lower initial rate offered by an ARM or the lower monthly payment afforded by an interest only mortgage. These programs are appropriate for some borrowers but also involve higher risk and less certainty. This is an excellent example of when selecting the lowest mortgage rate may not make sense. The example also reinforces why borrowers should carefully review the loan programs for the rates they compare to make sure their comparison is apples-to-apples and not fixed rate to ARM.
Review What Mortgage Program is Right for Me?
In addition to understanding what type of loan you are comparing, it is also important to recognize that different mortgage programs have different rates. For example, FHA, VA and USDA mortgage rates are usually lower than the rate for a conventional loan, which is a home loan that is not backed by a government program. These government-backed programs, however, require borrowers to pay mortgage insurance which is an additional cost you may not be required to pay with a conventional loan, depending on your loan-to-value (LTV) ratio. Borrowers should be sure to understand their total cost, including mortgage insurance, when comparing rates for different loan programs.
Review Rates for Different Mortgage Lengths
Just as mortgage rates vary depending on the loan program, they also vary by the length of the loan. Mortgages with shorter loan terms, such as 10, 15 and 20 year loans, have lower interest rates than loans with longer terms, such as a 30 year loan. The flipside of the lower mortgage rate for a shorter term loan is that the monthly mortgage payment is higher. This may seem counter intuitive because the mortgage rate is lower, but paying back the mortgage over a shorter period of time means you pay more principal with each payment which explains why your monthly payment is higher.
Understand What Length Mortgage Should I Choose?
When you compare mortgage rates, make sure you are comparing loans with the same length. Additionally, while mortgages with shorter terms have lower rates and can save you thousands of dollars in interest expense, borrowers need to be comfortable with the higher monthly payment as compared to a 30 year loan.
Watch Out for Discount Points
Extra costs such as discount points and lender origination fees can influence the mortgage rate you pay. In short, a discount point is a optional fee that borrowers can elect to pay to lower their mortgage rate. As a general rule, one discount point equates to approximately 0.250% in mortgage rate. So a mortgage rate of 4.500% without any discount points should be approximately 4.250% if you choose to pay a discount point. It is 100% up to borrowers to decide if they want to pay discount points.
The issue when you are comparing mortgage rates, is that some lenders assume you are paying discount points when they provide rate quotes, which enables them to offer a lower rate. Other lenders may not include discount points in their quotes, which makes the rate comparison less meaningful. While you may decide to pay discount points, you should always compare mortgage rates that use the same assumptions. To make the comparison as easy as possible, we recommend that borrowers request rate pricing from lenders that assumes no discount points. You can always elect to pay discount points after you find the lender that offers the lowest mortgage rate.
Should You Pay Discount Points?
Understand How Closing Costs Impact Mortgage Rates (Especially Origination Fees)
When you compare mortgage rates you should also understand the amount of closing costs charged by the lender as there is a trade-off between the two. In short, the higher the closing costs, the lower the mortgage rate, and vice versa. In some cases lenders include higher fees so that they can charge you a lower mortgage rate. Specifically, some lenders charge a higher origination fee, which is a fee for processing your mortgage, while other lenders charge no origination fee. In some ways an origination fee is similar to discount points except that borrowers are required to pay the fee instead of it being an optional expense.
Paying higher closing costs for a lower mortgage rate may make sense but make sure that the extra upfront cost can be recovered with a lower monthly payment within a reasonable period of time. For example, if the lender is charging you $5,000 in extra closing costs to lower your monthly payment by only $50, then it may not make sense to pay the higher costs to get the lower mortgage rate. In this example, it takes 100 months to recover the costs ($5,000 (extra costs) / $50 (monthly savings) = 100 months to recover costs), so you are probably better off paying the higher mortgage rate and closing costs.
One figure you can use to compare mortgage rates and closing costs at the same time is the annual percentage rate (APR). The APR is complicated to calculate but it basically is a single number that reflects both your mortgage rate and closing costs. For example, for a mortgage with no closing costs, the APR equals the mortgage rate. Borrowers can use the APR as a tool to find the loan with the lowest combination of mortgage rate and closing costs.
The table below compares mortgage rates, closing costs and APRs for lenders near you. To shop for your mortgage, contact multiple lenders in the table.
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Check the Rate Lock Period
Most lenders quote you loan terms, including mortgage rates, that are applicable for a set length of time, usually between 15 to 60 days. The period of time the terms are valid for is called the rate lock period and in some cases rates vary depending on the length of the lock period. It is important to understand the lock period when you compare mortgage rates so that you know how long the loan terms are good for and you can make sure you are comparing similar quotes.
For example, if one lender is quoting you a rate with a 15 day lock period and another lender is quoting the same rate with a 45 day lock period, the proposal with the longer lock period is much more attractive for several reasons. First off, it is unlikely that you can close your mortgage in 15 days so that quote carries significantly less weight. Second, the longer lock period provides greater certain which makes the proposal more credible.
In an ideal scenario the lender that offers the lowest mortgage rate also offers the longest lock period but it is always import to check how long the loan proposal is good for because market conditions are dynamic and change on a daily basis.
Sources
“Explore interest rates.” CFPB. Consumer Financial Protection Bureau, 2020. Web.