Understanding the Market

When it comes to any kind of financing we're all told to look for the lender who has the lowest rate. The truth is, there are over 10,000 mortgage companies and only one can have the lowest rate. Due to high regulation and competition, most lenders will be within 1/4 percent of one another. Because of this general rate equality, it's important for consumers to focus on getting the best loan, rather than necessarily getting the best rate.

So what does that look like?

Getting the best out of your mortgage really consists of covering the 'Big 3':

1. Cash: You'll want your mortgage to be set up in a way that ensures you have the optimal amount of money left over when everything is said and done. The more money you have available in case of emergency or investment opportunities, the better.

2. Payment: Having a payment that is both affordable and ideal is crucial to getting the most out of your loan. You can have a payment that is low and affordable, but if it is set to adjust up in the future or doesn't allow principal reduction to pay the house off when you want then it's not ideal.

3. Loan Term: The last (but not least!) of the Big 3 is Loan Term. Loan term is important not just for goals far down the road, but also in the short term as well. Even if you don't plan to stay in your loan through its final payment your loan's term will have a huge impact on the amount of principal you owe when you sell your home or refinance in the future.

Ultimately, getting a good rate is very important, but what's most important is having the cash you need on hand, getting a payment that's both affordable and ideal, along with a term that sets you up for success down the road. 

If you've ever turned on CNN or CNBC you may have seen a headline that read "Mortgage rates near all time low" or "Feds announce rate hike".

So, what causes this?

In short, supply and demand. Think of it like this: when the value of something goes up so will the price, and vice versa. Interest rates work the same way; as the economy gets stronger, the US dollar is worth more and therefore is more expensive to borrower; when the economy is performing poorly, the US dollar is less valuable so it is cheaper to borrower.

The past few years, the US government has bought trillions of dollars in mortgage backed securities (MBS's) which as played a big effort in keeping rates near all time lows for such an extended period of time. In the early summer of 2013 they announced that they might begin lowering the amount of mortgage bonds they would buy. Just the announcement caused other investors to stop buying, creating a dramatic rate hike.

Other factors such as wars or international economic crises can actually cause rates to drop. This occurs because the instability and fear of chaos causes investors to shift their money away from riskier ventures into something safer. Historically MBS's are one of the safest returns since the holder of the bond is ultimately paid by the homeowner, making them a pretty safe bet.

Overall, it almost always circles back to the US dollar. Generally, the only time we see interest rates rise are during prosperous economic times. When the stock market, real estate investments, and retirement accounts are all getting higher interest returns, so do mortgage lenders!

While Interest rates and closing costs are two separate charges you pay as a borrower, they really correlate hand in hand. The best way to visualize this is with a teeter-totter. 

Start with it being even with "standard costs" (title company charges, escrow accounts, etc) on one side and whatever the "going rate" is on the other. From there, if one goes up the other goes down. For example, if you want lower than the 'going rate', it's possible, but the closing cost side of the teeter totter will go up. On the contrary in order to obtain lower closing costs you will receive higher rate.

From the lender's perspective, they can make money via interest rates and/or closing costs. So they can offer a lower interest rate and make up for it with higher costs and vice versa. Discount points allow you to "buy" a cheaper interest rate while lender credits are used to lower closing costs.

We're often told to ask mortgage lenders "what is your rate", but what we really mean to ask is "what is your APR". Remember, interest paid on a loan is just one of the ways lenders make their profit. Another way they make money is via closing costs. A lender may offer an extremely low rate, but they may only be able to do so by charging additional discount points. 

Some lenders use our sensitivity to interest rates to their advantage and offer low rates, but make up for it by charging extremely high closing costs.

In an effort to allow consumers to shop from lender to lender fairly and with equal ground, the APR was created.  The APR takes into account not only the interest rate, but other closing costs in the loan as well. In effect, the APR translates the closing costs along with the note rate into an 'overall' interest rate, giving equal comparison opportunities to consumers. 

While the APR proves itself to be a useful tool, it's extremely important to look at interest rates and closing costs separately and always keep in mind that they aren't the most important components to your loan. It's what you get for those things that is truly important - always remember the 'Big 3'.