Mortgage rates may be low, but there's still a big difference between a 2.5%, 3%, and 4%+ rate. I take a look at the factors that determine your mortgage rate and calculate how much you'll pay.
Est. read time ~ 5min
When you start looking to buy a house, you’re going to hear all about mortgage rates and how much it sucks that they’re going up, how great it is if they’re going down, or even why low mortgage rates aren’t always a good thing.
Your mortgage rate is simply the amount of interest charged by whomever you took a loan out with to purchase your house.
So how do you get to this percentage? And how will it really affect how much you pay? For the purposes of this article, I’ll take a look at how just a 1% difference in your mortgage rate can seriously affect how much you pay.
As you’ll see in the table below, a 1% difference in mortgage rate on a $300,000 home with a 3% down payment of $9,000 has a $291,000 mortgage and a 1% increase from 2.5% to 3.5 % increases your monthly payment by almost $150 and increases your interest paid to the bank about $200. Although the difference in monthly payment may not seem that extreme, the 1% higher rate means you’ll pay approximately $57,000 more in interest over the 30-year term. Ouch!
What’s Ahead:
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How a 1% difference in your mortgage rate affects how much you pay
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What’s currently happening with mortgage rates?
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Determining factors in your mortgage rate
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Mortgage point – here’s why they matter
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Summary
How a 1% difference in your mortgage rate affects how much you pay
In this example, let’s say you’re looking to take out a home loan for $300,000. If you get a 30-year mortgage and you put down a 3% down payment of $9,000, you’ll have a $291,000 mortgage. And the following table will show you how much you will pay over the life of the loan at 3%— Of course, if you put more money down you will be paying less in interest both monthly and overall and this is a conversation you could and SHOULD be having with a qualified lending professional. The following is only a simple example and does not account for your current credit score, taxes, insurance, mortgage insurance, homeowners insurance, HOA fee’s and etc., but more to simply demonstrate the point about how interest can really start affecting you over time and hurt your ability to build equity.
Mortgage Interest paid at 3%
In this example, a 1% difference in mortgage rate results in a monthly payment that’s close to $120 higher. But the real difference is how much more you’ll pay in interest over 30 years…more than $55,000! And just think, if you lived in the 1980s when the highest mortgage rate was 18%, you’d be paying thousands a month just in interest!
If you’ve been looking at mortgage rates, you’ve likely heard that they’re at an all-time low.
COVID-19 pushed interest rates down, but they’re up slightly from the record low they reached a few weeks ago, as demand continues to increase. Still, a 3.65% interest rate is much lower than where rates sat one year ago, at 4.28% (which is exactly when I bought my house).
Considering that back in the 80s, a typical mortgage rate was between 10% and 18%, that number is even more impressive.
These days, a higher mortgage rate is considered over 4%. Of course, the cost of real estate has risen, but mortgage rates are still substantially lower than they could be.
Still, you’ll want to do all you can to get a lower rate. The first step is to shop around to get the lowest rates available.
What is the difference between a fixed-rate mortgage and an adjustable-rate mortgage?
It’s mortgage rates 101: the difference between a fixed and adjustable rate home loan. Just like it sounds, a fixed rate mortgage stays at the same interest rate for as long as you are paying down the loan, regardless of whether interest rates, in general, go up or down.
Conversely, an adjustable rate mortgage can go up (and sometimes down) based upon the overall interest rate market. Sometimes it is possible to get an adjustable rate mortgage at a much lower interest rate than a fixed rate mortgage, but the rate could skyrocket in a matter of a few years.
Other adjustable rate mortgages (also called ARMs), include a very low introductory mortgage rate for five or seven years, followed by a much higher rate. These loans are designed for home buyers who expect to live in their home a very short period of time, to refinance at a later date, or to flip the home for investment purposes.
While adjustable rate mortgages can be a valuable home buying tool in certain situations, they can also be dangerous, and are partially responsible for the massive rise in foreclosures and collapse of real estate prices that sparked the 2008 recession.
What are mortgage points?
Mortgage points are essentially fees that you pay on a mortgage loan when the loan is distributed. One point is equal to 1% of the mortgage value. So, on a $250,000 mortgage, one point would equal $2,500.
Why would anybody pay mortgage points? Good question. In many cases, if a borrower has poor credit or lending is especially tight, a home buyer may have to pay points to be able to get any mortgage loan at all.
Often, however, mortgage lenders will offer the option of paying points in exchange for a lower interest rate on the mortgage. Sometimes, paying points can actually save a homebuyer money over the life of a mortgage. A reputable mortgage broker should be able to show you how a different points/interest rate combination might apply to your situation (whether you intend to live in your home for 50 years or sell in 5, for example). You can also get several competing mortgage quotes online pretty quickly, and use banks’ online quote tools to compare rates.
