Just like how some might think that the cheaper of two different car listings of the same model on a used car portal is more affordable.
But as we all know that is not the case.
Various other factors can come into play that makes the price of something the least material factor in determining it’s actual costs.
The biggest marketing concept of lenders and financial institutions have sold us through mass media advertising is this line of thought.
So much so that most of the posters and advertisements of mortgages and loans we see all over the place these days put the interest rate in bold as the point of focus. And usually nothing else about the other costs except for an asterick at the bottom indicating a hint of other costs which a borrower would incur.
The reason why may homeowners might actually pay more for their home loans if they were to accept a low rate mortgage is that there are various other fees and costs involved which they think are negligible.
For example, a company might charge you 3 times the upfront costs compared to another but with a 0.25% lower interest rate on the loan. Because a new home buyer might assume that these are standard costs that have little deviation, he accepted the “cheaper” loan with a measly 0.25% savings but ends up paying through his nose on initial costs.
It might still be worthwhile over the long term of maybe 20 years. But these days few people hold onto a mortgage for that long without refinancing.
The various expense items that make up total mortgage costs are explained and broken down here.
But for a quick recap, they are:
As you can see, there are various components that make up total costs of home loans. The interest rate is just one of them that we see on the surface thinking that it’s all that matters when in truth, it’s far from that assumption.
On top of this, one has to consider that the fees that make up the 6 cost components are the revenue generators for service providers that provide the services that closes the loan.
For example, points contribute to a huge portion of a broker’s revenue stream. And it ultimately comes from the pockets of the borrowers.
Do you think for a moment that these businesses would allow a borrower to get away scot-free without getting paid?
To property evaluate a mortgage, the best way is to obtain at least 3 quotes from 3 different lenders.
Avoid making the mistake of only obtaining the interest rate. Get all the cost components. And they have to be done on the same day as mortgage rates can fluctuate on a daily basis.
This means that comparing a quote from a lender a week ago can mean an unmeaningful comparison with another which is obtained today.
For example, a quote you obtained last week might give you 5% while a new one from a different source offers you 5.25% under the same terms. If you had obtained the quote from the second lender a week ago, you might have got 4.75%!
A generally and fairly dependable way to compare between loan quotes is to compare their APR. This shows their costs when all the same variables are accounted for.
When interest rate is the main decision criteria, studies have shown that most people don’t end up reaping the projected “savings” from a lower interest rate.
The primary reasons being that most borrowers fully pay off their loans way before the breakeven point and actually makes a loss in the bigger picture of things.
You could very well do the same as well when you’ve received a windfall, got a promotion, made a killing with investments, etc.
So while the pragmatic way is to have a long term view of long term debt obligations like mortgages, that is not the only angle to view them.
The last thing you want is to get hit by a blind spot when you could have easily avoid huge extra expenses if only you had been more cautious.
The biggest take away from all of these is that interest rates mislead you to thinking you have a great deal when the truth is that you have been paying much more than you really have to.
The most basic yet effective way to choose a mortgage
I’ve met people who run all types of equations and formulas to assess the real costs of the home loans they’re considering.
But in most cases, the easiest and effective way to compare the prices of different loans is a basic 4 step process.
List down all the upfront loan expenses and add them all up.
Multiply the monthly installment amount by the number of months in the whole term, or by the number of months you planned to keep the loan.
Sum up the total amount by adding the figures calculated from step 1 and step 2.
Subtract the principal that you are borrowing from the lender from the figure you’ve tabulated in step 3.
The figure you get as a result of following the 4 simple steps would be the total costs of the mortgage.
Do the same with all the quotes you’ve shortlisted and select the one with the lowest costs.
You are welcome.