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Interest Rates Have Dropped
Is Now the Time to Buy or Refinance?
Everyone wants a deal. Whether you're buying lunch or a designer suit, if you believe you spent too much money, it will ruin your day. On the other hand, if you obtain a great discount, you'll be smiling all week long.
So what's a homeowner or home buyer to do? After increasing steadily over the last two years, mortgage rates have finally dropped. But despite this recent decrease, fixed interest rates are still a half point higher than they were two years ago. For anyone who's looking to buy a home or refinance a mortgage, it may be tempting to sit on the sidelines and wait for rates to drop even lower in the hopes of getting a "great deal."
When you take into account closing costs, which average over $3,000 on a $200,000 mortgage, waiting becomes even enticing. But should closing costs even factor into your decision? The answer is no. If you are considering refinancing or buying your next home, you should do it now!
If you were to buy a house today, it's likely that you'll live there for five to seven years. Nowadays, it is very rare for a homeowner to move into a house and remain there for thirty years. Rarer still is the homeowner who has the same mortgage in effect for longer than a few years. Over the last decade, it's become common practice to refinance frequently, either due to a lowering of interest rates or events taking place in the homeowner's life.
The most important thing to consider when choosing a mortgage is how much it will cost during the time it's in effect. Getting the lowest interest rate won't be worth it in the long run if the costs required to obtain it outweigh the benefits.
Take points, for example. Many people wonder whether paying points up front in order to obtain a lower interest rate is worth it. The simple answer is, it depends. In some cases, the timeframe required to take advantage of a lower interest rate can be nearly six years. Let's look at an example using a $200,000 mortgage.
If the average interest rate for a 30-Year Fixed Rate Mortgage was 6.50% with no points and no origination fees, it would result in a total monthly payment of $1,264. If a borrower wanted to reduce the interest rate to 6.00%, or achieve a mortgage payment of $1,199, the points required to do so would run approximately 1.50% or $3,000. Based on the monthly savings in this case, it would take nearly four years to break even.
Many experts predict that the Federal Reserve will be forced to decrease interest rates in 2007 as the economy slows down. When interest rates decline, many people take advantage of the reduction and refinance into a lower rate and lower payment. For those individuals who paid higher closing costs to realize a lower interest rate, this money would be lost if they refinanced before reaching the "break even" point.
Perhaps the best strategy for today's market is to obtain a "Low Closing Costs" or "No Closing Costs" mortgage. Under this scenario, a borrower would actually choose to take an interest rate that's higher than the average market rate in effect, with no points or origination fees. Using the example from above, let's imagine the interest rate for a loan with zero points/zero origination fees is 6.50%. If a borrower accepts an interest rate of 7.00%, many lenders will actually pay all or a majority of the closing costs.
Why would someone choose to go with a higher interest rate? Let's examine the numbers. The payment for a $200,000 mortgage with a rate of 6.50% is $1,264, while the same mortgage with a 7.00% interest rate carries a payment of $1,331. So, while the payment is $67 more a month with the higher rate, the borrower saves paying $3,000 in costs up front.
It would take nearly four years to end up paying more by accepting the higher interest rate with no closing costs than it would by taking the lower rate and paying closing costs up front. Another bonus of this scenario is the tax benefit. Typically, closing costs are not tax-deductible while the interest paid on your home mortgage is. In taking the higher rate, the extra money spent on interest would provide someone in a 31% effective tax bracket over $300 in taxable income savings each year that the mortgage is in effect.
*Please note: Closing costs vary by state, loan amount, and by specific borrower and lender requirements. In a recent state-by-state closing costs survey conducted by BankRate.com, the closing costs for a $200,000 mortgage ranged from a low of $2,713 to a high of $3,887, with an average of $3,024. The illustrations above are for comparison purposes only and may not apply to your specific loan.
If you are considering either buying a home or restructuring your finances at this time, ask your mortgage professional to show you the benefits of having your lender pay the closing costs. If interest rates go down in the next 12-24 months and you choose to exit your mortgage, you could save more than $1,600 simply by going with a mortgage that carries a higher interest rate.
As with any major financial decision, it is important to consider all the factors before moving forward. Before you ask your lender, "What's your best rate?", make sure that you ask about all of the available options. You may just find that getting the lowest interest rate could cost you a lot of money.
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