If you’ve noticed I’ve been a little quiet around Mrs. Millennial lately, there’s a good reason for that. We’ve been caught up in the process of buying a second home/vacation home in Houston, where a good chunk of my family lives and where we regularly visit for concerts, museum openings, foodie events and more.
(Wait! I thought millennials didn’t buy homes! What’s this one doing here with TWO? Ahhh, the cognitive dissonance is killing me!! Anyways….)
Buying a second home is pretty much exactly the same as buying a first home, right down to the interest rates you’re likely to be offered by the banks. So you can imagine my mortgage broker’s surprise today when I told him I’d prefer to pass on his lower interest rate mortgage offer, and take one with a slightly *HIGHER* rate instead. “Almost no one asks me to do it this way, but we can if you want,” he gamely told me.
But the reason was pretty simple if you added in two additional data points to the equation: the amount of “points” we were being asked to pay, and the amount of time we actually plan to use to pay off the house.
Points are essentially a surcharge you can pay to the bank in order to “buy” a lower interest rate. The bank keeps this money — it doesn’t go towards your principle the way earnest money or your down payment does.
In this situation, we were being offered a 3.875% interest rate — but with two “points” equivalent to 2% of the loan added to our closing costs up front, or a 4.25% mortgage with no points. So how do you decide between the two? It’s your old friend MATH! But, lucky you, there are actually plenty of calculators online to help do the math for you.
Let’s take an imaginary $100,000 loan as an example, just to keep the math easy. According to the calculator at Bankrate, if I was offered the two above rates on a 30-year mortgage, and I actually intended to take the full 30-years to pay if off (that last part being the kicker) then it would ABSOLUTELY make more sense to take the lower rate:
But what if you’re not planning on taking the full 30 years to pay off your mortgage? What if you’re only going to take 10 years? Or even just 5?
If you’re able to pay off your mortgage amount earlier, then you may not have enough time to “recoup” the points amount. Meaning that it can absolutely be worth it to take a slightly higher interest rate in order to not have to pay points. In our example above, if you paid off your mortgage at any point before 11 years, then it would actually cost you money to take the points.
Surely your mortgage broker will tell you what’s best for your situation, though, right? Don’t count on it. States vary on whether a mortgage broker owes a borrower a fiduciary duty, and in our state, Texas, case law says that they don’t owe such a duty. (Translated from legalese? Your mortgage agent’s job is to make money for the bank, not work in your best interest.)
So, if like us, you’re looking at buying a new property, do the math! In some cases, a higher interest rate (and no points!) can actually save you thousands over a lower interest rate in the long run.
Header photo courtesy of Flickr user Bennilover under a Creative Commons license.
