How to select the right mortgage when a lender quotes different interest rates and closing costs

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated October 20, 2020

If you are comparing loan quotes from multiple lenders you are already ahead of the game when it comes to getting a mortgage.  Reviewing proposals from at least five lenders is the best way to save money on your loan.

Choosing the right mortgage from several quotes, however, can be confusing and overwhelming.  One lender may quote you a lower mortgage rate with higher closing costs while another lender proposes a higher rate and lower costs.

Because the process can be challenging, we explain how to select a mortgage from quotes with different interest rates and closing costs.  Continue reading to understand the dynamic between your mortgage rate and costs, when you should pay a lower rate and higher costs and vice versa, and how to choose the mortgage that best fits your individual needs.

Understand the Trade Off Between Your Mortgage Rate and Closing Costs

When you shop for a mortgage, there is typically a trade-off between the mortgage rate the lender charges and the closing costs you pay. In an ideal scenario you can find a mortgage with both a low rate and closing costs but usually the lower your mortgage rate, the higher your closing costs and vice versa.

For example, a lender may offer you a 4.000% interest rate with $2,500 in closing costs as compared to a 4.250% rate with $500 in costs. In some cases if your pay a high enough mortgage rate, you have no closing costs or you may receive a rebate from the lender to offset all or part of your costs.

Below we demonstrate how your interest rate impacts your mortgage payment and total interest expense, which helps you better understand the trade-off between your rate and closing costs. In this example we compare the monthly payment and total interest cost for a $250,000 loan with a 4.000% interest rate and $2,500 in closing costs to a loan with a 4.250% rate and $500 in costs.

Case 1: 4.000% mortgage rate / $2,500 closing costs

Mortgage Payment: $1,194

Total Interest Expense: $179,674

Closing Costs: $2,500

Case 2: 4.250% mortgage rate / $500 closing costs

Mortgage Payment: $1,230

Total Interest Expense: $192,746

Closing Costs: $500

In the first case, you pay $2,000 more in closing costs but your mortgage payment is $36 lower and you save $13,072 in interest expense over the life of the mortgage. In the second case, your monthly payment and interest cost are higher but you save $2,000 in closing costs.

Your actual mortgage terms vary depending on many factors including the lender, mortgage amount, loan program and location but the example above helps you understand the relationship between your interest rate and closing costs.

Use ourMORTGAGE COMPARISON CALCULATORto compare loans with different rates and closing costs

So should you choose a loan with a lower mortgage rate and higher closing costs or a loan with a higher rate and lower costs? The answer depends on your personal situation and financing objectives.

When You Should Pay a Lower Mortgage Rate and Higher Closing Costs

Paying a lower mortgage rate is usually the most cost-effective option for most borrowers because it saves you money in the long run. We review multiple cases when choosing a mortgage with a lower rate and higher costs makes sense.

You want the lowest monthly mortgage payment

You want to minimize your total interest expense over the life of the mortgage

You plan to live in the home for at least five years (this enables you to recover the higher closing costs over a longer period of time)

You have sufficient funds for your closing costs, down payment and financial reserves, if applicable

Use our personalized mortgage quote feature to review loan quotes from top-rated lenders.  Our quote form is free, easy-to-use and does not impact your credit. 

When You Should Pay Lower Closing Costs and a Higher Mortgage Rate

There are also scenarios when paying a higher mortgage rate and lower closing costs is the right approach. Paying a higher rate reduces your costs which means you are required to pay less money upfront to get a mortgage. This approach makes the most sense if the following circumstances apply to you:

You lack the funds to pay for closing costs or other mortgage expenses

You plan to live in the home for a short period of time, so you have less time to recover your closing costs

Choose the Mortgage That Matches Your Priorities

Choosing the mortgage that is right for you comes down to your financial situation and mortgage priorities. If you are looking to save money on your monthly payment and interest expense over the long term, then paying a lower mortgage rate and higher closing costs is the right option. If you are looking to reduce your upfront costs and you intend to have the loan for a shorter period of time, then paying a higher rate and lower closing costs may be the better approach.

Always Shop Lenders to Find the Best Mortgage Terms

Regardless of the option that best fits your situation, we always recommend that you shop lenders to find the mortgage that is right for you. The table below compares loan terms for leading lenders in your area. Contact multiple lenders to find the lowest combination of mortgage rate and closing costs.

Sources

"Looking for the Best Mortgage."  FDIC.  Federal Deposit Insurance Corporation, October 4 2016.  Web.