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The financial world is all abuzz that lower interest rates are coming. At this writing, it is a forgone conclusion that the Federal Reserve will lower interest rates when they meet in September. But because the market has already priced in a reduction in interest rates there is a strong probability that the market will not respond to the action.
Mortgage rates have dropped from a range of 7.5% earlier this year to 6.5% to 7% when this is being written in Mid August. Since the Caroline Review hits the streets the beginning of a month and you will be reading this sometime in September, it is possible that mortgage rates may be lower, or higher or…. Wait for it… they may be the same!
I guarantee that one of those three predictions will be correct.
When checking out mortgage rates, it is important to understand that there is no ONE mortgage rate that is available to everyone. There are two major variables that will impact the interest rate that you will pay, other than the mortgage loan program. Credit score, which is controlled by you the consumer, and discount points or loan fees, which are controlled by the market.
Conventional loan rates, which are loans that are sold to Fannie Mae or Freddie Mac are especially sensitive to a borrower’s credit score. The lower the credit score the higher the interest rate. Borrowers with credit scores in the low to mid 600’s could pay a rate 1%-1.5% higher than a borrower with credit scores in the high 700’s. The goal for anyone is to manage your credit appropriately so you can acquire and maintain a high credit score. Doing so can save thousands of dollars in interest expense.
This is not to say that other loan programs such as USDA, FHA, and VA do not assess higher rates for those with lower credit scores, they do. Just not as severely.
Paying points are a way to permanently lower your interest rate by prepaying interest up front in the form of points. Points equal 1% of the amount of the loan and when paid will lower the interest rate for the life of the loan. Generally speaking, every one point (1% of loan) you pay at closing will lower your interest rate .25%. An example: assume you are borrowing $300.000, and the 30-year fixed rate is 7% with 0 points, with a principal and interest payment of $1,995.91. If you pay 1 point ($3,000) the rate would drop to 6.75% and the payment would be $1,945.79, saving $50 per month. Sounds like “wow what a deal” right? Let’s take it one step further.
Doing simple math, you can quickly determine that it will take 60 months to get your money back. ($3,000 divided by $50 is 60 months or 5 years). You may think that this is a good deal because over the full 30-year term of the loan you will save a total of $15,000. To this I say, “no you won’t,” because there is a greater than 90% probability that you will not have that loan for 30 years.
If you sell or refinance in less than 60 months, you will fail to get your $3,000 back. Not only did you lose money but you also lost the opportunity to be paid interest if you invested the $3,000 in a money market fund or CD. With today’s savings rates in the 5% range, you could potentially earn $300 to $400 per year in interest and retain the opportunity to use the money at any time for whatever you want to do. But if you pay the $3,000 to buy down the rate, you will not have the use of that money again. Plus, it is highly unlikely that the $50 per month you are saving in mortgage payment does not impact your financial life at all.
There no benefit to paying additional points. Double the cost for double the benefit, the time of recoup the investment does not change. $6,000 divided by 99 months is 60.6 months, the same as if you paid 1 point.
If you are a homeowner with a mortgage who has been solicited to refinance, you need to pay particular attention to how much your monthly payment will drop. Some aggressive lenders will try to convince you that is a smart move to pay $8,000 in costs to save $100 per month, which it is not.
Make sure you look at your mortgage payment as an investment. Every payment you make chips away at the principal which is your equity. And every subsequent payment you make increases the amount of principal being paid.
Let me make this point very clear. IF YOU HAVE TO PAY POINTS IN ORDER TO JUSTIFY REFINANCING THAT IS YOUR TRIGGER TO NOT REFINACE.
Mortgage rates have dropped over the last four to six months with much of the drop happening in the last 30 - 45 days in anticipation of the Federal Reserve lowering interest rates. The average mortgage rate hit 6.47% as of August 7, which was a 15-month low and set the table for interest rates to price in a .25% drop in rates by the Fed at their next meeting on September 17 and 18. If they do as expected, then the market may not respond because it has already priced this decrease in August. The actual event of lowering the rate may be a non-event for the market and rates do not move.
