Mortgage 101

The process of purchasing a home can be both an exciting and stressful time in life. There are so many factors for a potential homebuyer to consider that it can feel overwhelming. Is this the right home for me? Can I afford this home? Is the home in good condition? All of these big considerations can create a situation where some of the small but important details can be missed. 

Take, for example, the decision to buy-down the interest rate on a home mortgage loan. Often a homebuyer simply chooses an interest rate that seems like a good choice at first glance, without considering whether that choice best aligns with their long-term financial goals. We’ll share an example of this, but first, let’s cover a couple of key definitions. 

First is the definition of a buy-down fee (a.k.a. points, or discount points), which is simply a one-time fee used to purchase a lower interest rate from your lender. Second is a lender credit, which is a credit provided by your lender for choosing a higher interest rate.

Here’s a hypothetical example of what a homebuyer would see when choosing an interest rate, and an explanation of what factors to consider when selecting an interest rate to lock.

Let’s say that Sarah is purchasing a home. She is under contract to purchase this home for $750,000 and would like a down payment of 20 percent. She will be using a 30-year fixed conventional loan to help her purchase this home. Sarah is in love with this home and plans on making it her “forever home”. When she begins working with her lender, she is given a choice between locking in three different interest rates as posted below. In this hypothetical example, Sarah was feeling some stress about making such a large purchase and decided to lock in the higher interest rate option because the idea of receiving a credit towards her closing costs sounded like a wise decision to her. Was her choice a good one?

Interest Rate Options:

  • 3.25% interest rate that would charge a buy-down fee of $2,500, and would have a monthly principal and interest payment of $2,611.24.
  • 3.375% interest rate that would not charge any buy-down fees, and would not pay any lender credits, with a monthly principal and interest payment of $2,652.58.
  • 3.50% interest rate that would pay a lender credit of $1,200, and would have a monthly principal and interest payment of $2,694.27.

While there is no right or wrong answer to the question posed above, here are some factors that may have benefited Sarah’s long-term financial goals had she taken the time to consider her options.

Sarah is planning on staying in this home forever, which means that she’ll likely be paying the loan off for the duration of its 30-year amortization period. When comparing the 3.50% option with the 3.25% option, Sarah could have saved herself just under $30,000 over the life of the loan had she selected the 3.25% interest rate. 

When comparing the 3.50% option with the 3.375% option, she could have saved herself a bit more than $15,000 over the life of the loan had she selected the 3.375% option.

Sarah may have ultimately been happy with the interest rate she chose to lock, but this example provides a good explanation of how some seemingly small details can have a relatively large impact on long-term financial goals.

Are you currently in the market for a mortgage or refinance? The Alpine Bank mortgage division can provide expert guidance.

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