Common myths about interest rates

"The better the interest rate, the better the loan"

While the rate attached to the mortgage is definitely a consideration, the program (30 year fixed, Option ARM, 5/1 ARM, Interest Only, etc.) plays a much larger role in how good the loan is for your specific situation.

A comprehensive analysis that examines the overall cost of a loan should always be prepared to see what is going to be best for you over the long run. Just a few of the factors you should take into consideration are the total closing costs, interest rate, how long you plan to be in the home, the likelihood of interest rate adjustments if you are taking out an adjustable rate mortgage, whether or not there are any prepayment penalties, etc.

For example, you may be offered an interest rate of 7.75% on a 30 year fixed loan and an interest rate of 7.5% on a 2/28 ARM with a 3 year prepayment penalty. You are told that you can refinance into a fixed rate after your credit improves. You think that sounds great. You take the lower interest rate of 7.5%.

In 2 years, you've made all your mortgage payments on time and your credit is looking much better. You'd like to refinance into a fixed interest rate program. You call your mortgage professional. But the problem is you have a prepayment penalty. You bought the home with no money down. There is not enough equity in your home to roll in all of the closing costs associated with refinancing and the prepayment penalty. You do not have enough money saved to pay these costs out of pocket. You are now stuck with an adjustable rate mortgage and increasing payments until you can come up with the money or you have enough equity built up in your home.

As you can see, it would have been much better to take the slightly higher interest rate of 7.75% and have the security of knowing that your payments would stay the same.

Another rate myth BUSTED!

One common myth about interest rates is that Adjustable Rate Mortgages always have lower starting rates than Fixed Rate Mortgages. Recently we've seen several times when starting rates for 5,7 and 10 year Adjustable Rate Mortgages were higher than 30 year Fixed Rate Mortgages.

Another myth about Adjustable Rate Mortgages (ARMs) is that the rate increases when it enters the adjustment period. The truth is that it will depend on the details of your mortgage, and what the "Floor Rate" is. The Floor Rate is the lowest possible rate allowed on an ARM, which is determined at the start of the loan and is detailed in your closing papers. It is common in SubPrime loans that the floor rate is the same as your starting rate, which means that in all likely hood your rate will increase when it enters the adjustment period. In conforming ARMs the Floor rate is often related to the Margin on the loan. Since the Margin is only a portion of the start rate, when it enters the adjustment period, your rate could increase or decrease.

A common myth about interest rates is that when you buy down an interest rate and pay one point, the interest rate decreases by 1%. In actuality when you pay one point to buy down an interest rate you will decrease the interest rate by only approximately .125%. Sometimes the rate buy-down will be slightly more than .125%, actually closer to .25%.
An example of buying down the rate would be:
For a $100,000 loan if you paid 1 point to buy a 7.5% interest rate down, it would cost you $1,000 and you new rate would be 7.375% instead of 7.5%. Consult a mortgage professional for more information on buying down interest rates or paying discount points.

When buying down your interest rate, you should have your mortgage consultant perform a calculation to determine if the cost of buying down the rate to obtain a lower rate will actually save you money! You will NEVER know unless you perform this test. Sometimes, the higher rate will be the lower cost loan by saving the point costs.

» DISCLAIMER: The information contained in this article on 'Common myths about interest rates' is a collection of contributions by licensed mortgage professionals and is not the opinion of Broker Outpost LLC. Always consult a licensed professional before applying for a mortgage.