How do I choose an interest Rate? First, it important to know that every rate offered for a specific product has a cost attached to it. That cost is usually expressed as a number above or below 100. For example, on a 30 year fixed loan a lender may offer a rate to a broker ranging from 3.5% to 4.75%. The “cost” of the rate at 3.5% may be expressed as 98.5 meaning that the consumer would have to pay 1.5% of the loan amount as a fee to the lender – not the broker, usually referred to as points.
If the consumer didn’t want to pay points they may choose a rate of 3.875%, for example, that has an associated price of 100.00. That is considered “PAR” meaning that the consumer won’t pay any points and the lender won’t give you a credit.
You may need a lender credit if you were buying a home and could benefit from lower closing costs, or the lender may pay the broker using that credit. In that case you would choose a slightly higher interest rate that includes the bank paying you a credit. An example of this may be an interest rate of 4.125 with an associated CREDIT of 2% expressed as a price of 102.00.
The question still remains how do I choose? As I said, it’s just math. Every interest rate will produce an associated principle and interest payment. Obviously the lower the rate the lower the payment, but the higher the cost.
Lets use the above figures and a fictitious principle and interest payment to illustrate the point. The P&I payment on 100K loan is $450 at 3.875% interest. If you choose 4.125% the payment jumps to $470 but the lender gives you a credit of $2000.00 It will take the lender 100 months to recover that credit – that is a great deal for you the consumer.
Now let’s say you choose 3.625% and the corresponding payment is $430 but the cost to you is $2000. Now it will take YOU 100 months to recover that fee which means it is a terrible deal for you.
How long should is too long? I usually recommend you recover any money you spend is 48 to 60 months unless you plan on being in the home a shorter time than that. Lender pricing changes constantly but usually benefits the borrower to take a slightly higher rate in exchange for large lender credits, also known as yield spread premium.
Don’t let your emotions drive your interest rate decisions! Learn the system and do the math!!
