With mortgage rates hovering around 5.5%, there might be the temptation to snag a 30-year fixed at say 4.875%, or 4.99% if a lender offers a promotional rate.
The same might be true of any home loan product, whether it’s a 5/1 ARM or 15-year fixed. Getting a rate just below a whole number.
After all, 4.99% sounds a lot better than 5.5%, and makes it feel like you’re still receiving something special.
But here’s the thing – a rate just below a key threshold may cost a lot more, and not actually deliver the savings you’re looking for.
It could do little more than make you feel good psychologically, without saving you much money. Or any money at all.
A 4.99% 30-Year Fixed Sounds Pretty Good, Doesn’t It?
This week, the 30-year fixed rose to 5.10%, per the latest Freddie Mac survey. In reality, it’s closer to 5.5% at a lot of banks and lenders.
And it doesn’t appear to be going down anytime soon. As it stands, we’re only about 50 basis points away from hitting that scary 6% mark, which hasn’t been seen since 2008.
Meanwhile, rates on the 15-year fixed mortgage are averaging roughly 4.40%, well above their recent levels around 2%.
Because we’re so close to some big psychological thresholds, mortgage lenders might start offering rates below these key levels to entice borrowers.
Or to simply make it seem like there are still some decent interest rates out there, despite the massive price increases.
At this point, a lender could just probably start advertising a 4.99% 30-year fixed and they’d probably make headlines. It’s essentially free PR.
But once you dig into the details, you might be disappointed in what you find.
Read the Fine Print on That Super Low Mortgage Rate
A while back, I wrote that you should watch out for low mortgage rates you have to pay for.
In short, lenders can advertise below-market rates if they tack on discount points to the deal.
At the moment, this is relatively common. Most of the big banks and mortgage lenders I’ve come across are advertising their mortgage rates WITH points required.
But in reality, this just means you’re buying down your interest rate, paying interest upfront as opposed to monthly over the course of the loan term.
So a lender might say sure, I’ll give you a 30-year fixed at 4.875%, but the closing costs are probably going to be astronomical.
Once you factor in the two discount points you have to pay (or however much they charge) , the rate might not appear all that attractive.
Let’s look at an example to illustrate my point:
|$500,000 loan amount||4.875% rate||5.25% rate|
|Monthly P&I payment||$2,646.04||$2,761.02|
|Breakeven point||~8 years|
If you really wanted that 30-year fixed rate below 5%, and the lender was willing to offer it at a cost of two discount points ($10,000) and an additional $5,000 in closing costs, you’d be on the hook for $15,000 at closing.
Meanwhile, you could have taken the slightly higher rate of 5.25% via their no cost refinance option in exchange for a monthly principal and interest payment that was just $115 more.
While you’d enjoy a lower payment each month with the 4.875% rate, it would take you nearly a decade to recoup those $15,000 in closing costs.
And let’s not forget about the eroding value of the dollar over that time. Today’s dollars will be more expensive than tomorrow’s dollars, but you’ll have given them away.
There’s also the thought of being house poor if a good chunk of your savings is tied up in the property.
Sure, your monthly payment is $115 less per month, but you might not even notice that. Conversely, having thousands evaporate from your checking account overnight could feel disastrous.
Try to Look at the Big Picture When Determining the Best Move
Now this isn’t to say that paying discount points is a bad decision. There are probably lots of scenarios where it makes sense to pay them.
Even in our example above, the hypothetical borrower who keeps the 4.875% mortgage for the full term would save roughly $25,000 depending on tax brackets and savings rates.
They’d maybe even save some money if they stayed in the loan for just 10 years.
But you kind of have to know you’re going to stay in the property and the loan for that long if you’re going to commit to paying a lot of closing costs.
If you’re not sure, but still want to save money, you could explore other rate options such as 4% or 4.125%, using our example from above.
It might turn out that it’s a lot cheaper to take a slightly higher rate, pushing a breakeven point on closing costs much closer, maybe only a few years.
And options are nice, especially if liquidity becomes a concern down the road.
There’s also the thought that mortgage rates have peaked and could come down later this year or in 2023.
In that case, paying points could bite you if you could have refinanced to a lower rate at that time.
Ultimately, plans change and folks don’t stay put for as long as they anticipate. It’s possible to get the best of both worlds if you’re not sure what you’ll do over the next decade.
Going all in on the lowest mortgage rate possible might be a bad call, especially with rates so much higher now than the start of 2022.
It’s almost akin to panic buying when prices are high, or selling your stocks during a market rout. It might make sense to pump the brakes and hope for better.
Lastly, focus on what you can do as a borrower to ensure you’re eligible for the lowest rates possible, regardless of what lenders are offering today.