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Low Rate Vs. Low Cost

Most people only care about two things when it comes to financing a home:

How much cash will I need at closing?
How much are my monthly payments?
Rate and cash to close are inversely related: the lower the rate the more cash needed to close and vice versa.

We get a rate sheet from each of our lenders every day that has a range of rates on them. Today’s rate sheet for an FHA loan has a rate as low as 3.25% and as high as 4.375%. The lower we go in rate the less the lender makes over time so the more they charge you upfront. Conversely, we can take a higher rate from the lender which means they will make more money over time so they charge you less upfront. We even get to a point where they will give you a credit to cover your closing costs, prepaids, and reserves.

Our compensation as a mortgage broker is a fixed percentage of the loan amount. There is no incentive for us to sell you a higher or lower rate. You pick the rate, whether 3.25%, 4.375% or anywhere in between, and it makes no difference in how much the bank is going to pay us at closing.

I am a big fan of bringing as little cash to the closing table as possible. This is Justin Harris personal philosophy. It doesn’t make me right. It’s just how I like to structure my loans.

Let’s dive into the numbers so you can see for yourself.

There are always a couple of sweet spots on the rate sheet. They are what I like to call the low rate and low cost options.

In this example, we are going to be assuming a purchase price of $325,000 with 3.5% down on an FHA loan. The total loan amount is $319,113:

PURCHASE PRICE - $325,000
LESS DOWN PAYMENT - $11,375
PLUS UFMIP - $5,488
TOTAL LOAN AMOUNT - $319,113

I am also going to assume the normal buyer/seller split on closing costs and that there is no credit from the seller to cover any of your closing costs, prepaids, and reserves.

3.25%

The low rate option based on today’s rate sheet is 3.25%.

Your total payment including taxes, insurance and mortgage insurance is $2,108/mo.:

PRINCIPAL & INTEREST - $1,389
MORTGAGE INSURANCE - $222
TAXES - $406
HOMEOWNER’S INSURANCE - $91
TOTAL PAYMENT - $2,108

Your total closing costs are $4,307:

COST/(CREDIT) FOR RATE - $3,395
CREDIT REPORT - $25
RECORDING FEE - $100
ESCROW FEE - $331
ALTA TITLE INSURANCE - $456
TOTAL CLOSING COSTS - $4,307

Your total prepaids are $4,642

15 DAYS INTEREST - $426
7 MONTHS TAXES - $2,844
15 MONTHS HOME OWNER’S INSURANCE - $1,372
TOTAL PREPAIDS - $4,642

Your total cash required at closing is $20,324:

DOWN PAYMENT - $11,375
CLOSING COSTS - $4,307
PREPAIDS - $4,642
TOTAL - $20,324

3.75%

The low cost option based on today’s rate sheet is 3.75%.

Your total payment including taxes, insurance and mortgage insurance is $2,197/mo.:

PRINCIPAL & INTEREST - $1,478
MORTGAGE INSURANCE - $222
TAXES - $406
HOMEOWNER’S INSURANCE - $91
TOTAL PAYMENT - $2,197

Your total closing costs are ($4,707):

COST/(CREDIT) FOR RATE - ($5,619)
CREDIT REPORT - $25
RECORDING FEE - $100
ESCROW FEE - $331
ALTA TITLE INSURANCE - $456
TOTAL CLOSING COSTS - ($4,707)

Your total prepaids are $4,707:

15 DAYS INTEREST - $492
7 MONTHS TAXES - $2,843
15 MONTHS HOME OWNER’S INSURANCE - $1,372
TOTAL PREPAIDS - $4,707

Your total cash required at closing is $11,375:

DOWN PAYMENT - $11,375
CLOSING COSTS - ($4,707)
PREPAIDS - $4,707
TOTAL - $11,375

To recap: The low rate option comes with a payment of $2,108/mo and cash to close of $20,324. The low cost option comes with a payment of $2,197/mo and cash to close of $11,375.

Which option is best for you?

There is no right or wrong answer. Everyone loves the low rate, but is it worth the additional upfront cost over time?

The best way to answer that is to divide the monthly payment savings of $89 ($2,197 less $2,108) into the additional cash required at closing of $8,949 ($20,324 less $11,375) which equals 100 ($8,949 divided by $89).

It would take you 100 months (8.3 years) to pay yourself back the $8,949 you would pay upfront with the $89 payment savings.

The average person refinances their home loan every 3 years. I would much rather keep $8,949 in my pocket in exchange for a slightly higher payment. If I could get the money back in 2.5 to 3 years I would look really hard at paying for the lower rate. 100 months just isn’t worth the gamble. If I sell or refinance the home before the 100th month I would have been better off with the higher payment.

Again, there is no right or wrong answer. It’s your loan and you are the one that has to make the payments. More often than not, people opt for the low cost option once we show them the numbers. But we aren’t going to make you feel bad or tell you that you’re wrong for going with the low rate option.

Do you like to have your cake and eat it too? I know I sure do.

The best way to do that is to get the seller to give you a credit to cover all your closing costs, prepaids and reserves. In this case, you would need a credit of $8,949 and you get the 3.25% rate and only need $11,375 to close the deal:

DOWN PAYMENT - $11,375
CLOSING COSTS - $4,307
PREPAIDS - $4,707
SELLER CREDIT - ($8,949)
TOTAL - $11,375

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