One of the many painful lessons I learned growing up was that you can actually try too hard to save money and end up spending more in the end. Unfortunately, mortgages definitely work this way. If you just focus on getting the absolute lowest rate and/or closing costs, you could end up spending a lot more time and money on your loan in the long run.
Mortgages can be complicated beasts at times; rates can even change in the same day. Because of this, it’s critical that you understand how the whole mortgage process works, especially all of the different costs associated with a mortgage.
I asked Jim Woodworth, one of our mortgage specialist team captains, about the consequences of only looking for the absolute lowest rate. He explains that, “We often find that the lowest possible rate does not make the most sense for most people. The upfront costs need to be factored in to see which option works best in the short term and long term.”
Lots of Costs
Besides paying your mortgage principle – the amount you actually borrowed – and interest, you’ll have to pay taxes and insurance (escrow) along with closing costs. All of these costs will be different based on what type of mortgage you get, the mortgage amount and even who it’s through. Just because you’ve found a lender that offers a lower rate than the competition doesn’t mean that’s the best mortgage provider to go with. There’s more to a mortgage than the interest rate.
For example, when your mortgage servicer charges you a monthly payment, the assumption probably is that the amount you pay includes the interest accrued along with “extra” money to pay down the principle loan amount so that 10, 20 or 30 years from now, you’ll have paid off your mortgage completely.
Interest-Only Mortgages
Sometimes you can get what’s called an interest-only mortgage (a.k.a. exotic or subprime mortgage) where for the first few years you only pay the interest on the loan. This is a lot cheaper, but after the interest-only time is up, you’re going to have a much higher payment to make each month.
People may get an interest-only loan assuming/hoping they’ll get a raise, bonus or better job by the time the interest plus principle payments begin. This type of loan can pose a danger for two reasons.
Since you’re not paying on the principle, if your home’s value goes down by the time you do start paying on the principle, you may end up owing more than your home is worth. There’s also the chance that you don’t get that big promotion you were waiting on, and you’re left with a monthly payment that you can’t afford.
Negative Amortizing Loans
Another type of loan that has an artificially low payment is a negative amortizing loan. An amortizing loan is what you would think of as a “normal” loan. It has a monthly payment that is calculated to pay off the loan in a specified amount of time. A negative amortizing loan doesn’t include interest in the monthly payment so the loan actually gets bigger as you pay on it.
So, now you know, when looking at different rate and loan options, make sure you learn about all the fees associated with the mortgage so you’re getting the best mortgage, not just the best rate. If you’d like to learn more about the different aspects of a mortgage, check out our Know Your Mortgage series!
As always, please jump into the conversation with any thoughts, comments or questions you have.
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