Nate’s sister just bought a house and was offered two different mortgage options. One has a lower interest rate with a higher closing cost and the other has a higher interest rate with a lower closing cost. Danielle and Nate walk through how they would make a decision on which mortgage to go with.
My sister is buying a house on her own! Fantastic. It’s a new construction which has some special considerations:
- Has to finance house through the builder
- Owes money on options (floors, cabinets, etc) when signing the agreement (house is scheduled to be completed in December)
- Upgrade considerations: value square footage over upgrades. Check the pricing on the upgrades.
- She’s choosing minimum all around and updating later – doesn’t like choices and prices
We are going to round all of the numbers for the sake of ease but here is what she is looking at:
- Purchase price is $190K
- Two mortgage options
- 1. Interest rate of 4.875%
- 1. Monthly mortgage will be $1660
- 1. Has to pay 1.5% closing cost (lender fee) which is roughly $3,000
- 2. Interest rate of 5.25%
- 2. Monthly mortgage will be $1700
- 2. No closing costs (lender fee)
So the question is, which mortgage should she take an why.
- Our immediate response is to take the lower interest rate. Here’s why
- 5.25% over 30 years is $612,000
- 4.875% over 30 years is $597,600
- The lower interest rate saves her $14,400
- Minus the $3,000 in closing she still saves over $11,000… over 30 years
- Her thought is to go with the higher interest mortgage because her plan is to live there for 5-7 years.
- She wants to save the $3,000 on her down payment and either put it on the house or use it to buy things for the house
- Need to calculate the payback period. $3,000/40= 75 months or 6 years and 3 months.
- So she’s right in her thinking. If she sells the place in 5-7 years she is either making or losing a small amount of money. If she sells in 5 years she will have saved $600 and if she sells in 7 years it will cost her $360
I would still always opt for the lower interest rate because plans can change, but I understand where she is coming from. As a single person, saving a larger chunk on money out of the gate is desirable.
There are some other things to consider. While she could save the money upfront and put it on the house, it could allow her to refinance sooner, and possibly get a lower interest rate.
Interest rates are on their way up and have been for some time. We think it’s better to lock in something lower than to hope that things are going to be lower in 5 years.
I don’t think she can make a truly disastrous decision on this. It’s more a gamble or short vs. long term.