Should you choose a mortgage with a lower mortgage rate and higher closing costs or a loan with a higher rate and lower costs?
When comparing two mortgage quotes, it usually makes financial sense to select the loan with the lowest mortgage rate as long as the closing costs are not significantly higher than your other financing option. Paying a lower rate results in a lower loan payment, which means you save money every month as compared to a mortgage with a higher rate.
A 30 year mortgage has 360 monthly payments so even if you only save $20 per month, that adds up to $7,200 over the course of your loan. So while you may pay higher closing costs upfront as a trade off to obtain the lower rate, this approach could save a significant amount of money in the long run.
For example, the monthly payment on a 30 year $175,000 mortgage with a 4.000% rate is $835 while the payment on a loan with a 4.375% rate is $874. In this case you save $39 dollars per month by selecting the mortgage with the lower interest rate, which equates to $14,040 in total savings over the entire loan ($39 in monthly savings x 360 payments = $14,040).
Use ourMortgage Comparison Calculatorto compare loans with different rates and closing costs
If you are required to pay higher closing costs to receive the lower mortgage rate, it is important to understand how long it takes you to recover the extra expense. You can do this by dividing the amount of your monthly payment savings into the difference in closing costs between the two proposals.
Returning t the example above, if the difference in closing costs for two loan quotes is $2,000, you recover the higher fees you paid upfront in approximately 51 months, or four and a quarter years, ($2,000 in extra closing costs / $39 savings per month = 51 months or ~ 4 years and three months).
This example also shows how the length of time you plan on owning the property factors into the decision process. In this scenario, if you plan on owning the home for at least four and a quarter years, then the loan with the lower mortgage rate and higher closing costs makes more financial sense because you can recover the higher costs you paid with your ongoing monthly savings.
If you plan on selling the home or refinancing sooner, then the loan with the lower closing costs and higher rate is likely the better option because you are not going to own the property long enough to justify the higher upfront expense associated with the lower rate. So when you compare mortgage proposals there are other factors to consider in addition to interest rates and closing costs including your time table and overall financial objectives.
In addition to how long you intend to own the property, there are other practical considerations to keep in mind including how much money you have saved for closing costs and reserves. If you have limited funds it may not be feasible for you to pay higher closing costs to obtain a lower mortgage rate.
Closing costs can run thousands of dollars and we also recommend that you keep sufficient funds in reserve to pay for three-to-six months of total housing expense in case you encounter financial challenges after your loan closes. Plus, you also need to come up with the funds for your down payment, which can be a significant amount of money.
In an ideal scenario you have enough funds in savings to select the mortgage option that is best for you in the long run -- including a loan with a lower rate and higher costs -- but this approach may not be financially feasible for all borrowers. In some cases, the decision is made for you based on your personal situation and how much you can afford to pay in closing costs.
Regardless of your financial circumstances, we always recommend that you compare multiple lenders to find the best loan terms. You may be able to find a lender that offers both the lowest rate and fees. This is why shopping for your loan and evaluating several proposals is the best way to save money on your mortgage. You can contact lenders in the table below to start the shopping process.
View All Lenders%
Sources
“Comparing Loan Offers.” CFPB. Consumer Financial Protection Bureau, 2017. Web.
More FREEandCLEAR Mortgage Resources
How to Compare Mortgage Proposals
Understand how to compare mortgage proposals from multiple lenders to find the loan with the most attractive terms. Learn the key items you should focus on and the documents you should use to compare multiple loan quotes.
Ways to Lower Mortgage Closing Costs
Review several tips for lowering your mortgage closing costs including having the property seller pay for costs, grants, lender rebates and other helpful ideas to help you reduce or pay for closing fees.