Why Interest Rates Do Not Matter As Much As You Think
When I graduated college in 2014, I was faced with the dilemma that most college graduates are hit with the day after you walk across the stage- what in the world am I going to do next? Go utilize my accounting degree (no thanks-appreciate the advanced problem solving skills, but I never wanted to see a company’s financial records again)? Travel the world? Get a job that helps pay the bills while providing me with good life experience? I went with the third by taking a job in the mortgage business. Thanks to a connection I had, I got taken on as an assistant by a top producer in Nashville who knew the industry in and out. It was a really tough job that involved a lot of arguing and putting up with the crap that most entry level positions have to deal with. However, I learned some things while in that role that no other job would have given me, and I think it really primed me for a career in housing.
If you’ve ever even considered buying a home, or listen to the news regarding the housing market or the mortgage industry, you’ve heard or thought, “what’re rates doing today?” When I had this job, I heard this question asked no less than five times a day. Rates would come out in the morning and mid-afternoon. It was basically like the video clips you see from the stock market floor where people are scrambling around and making phone calls. Decisions would be made to lock loans in, or let them “float”, which means to wait until the market has a change to decide to lock in the rate. By “locking in a rate”, the borrower is agreeing to a rate and locking in for a fixed amount of time, usually a 30 or 60 day timeframe. The next variable, is the cost of that rate.
Rate sheets are created off of a grid system. What I mean by that is this- the loan officer puts in all of your loan variables into the system (credit score, price of the home, loan-to-value, etc.) and then runs what your rates would look like. When the rates are produced, a grid would pop up showing rates 3.00%-6%, for example. There were options for 30, 60, 90 and 120 day locks. On a 30 day lock, 4.125% might be considered “even”, or showing as the par rate that day. A borrower could say, “I refuse to have anything above 3.75%, what is this going to cost me?” Depending on loan amounts, LTV (loan-to-value) and some other factors, let’s say this would save you $30 a month in payment. Sounds like a no-brainer, right? However, it’s going to cost you $3,500 to lower this rate, because this rate is considered below par and the lender has to buy down to that rate. The game then becomes doing the math to see if it makes sense to do this. Yes, the accounting nerd in me considers this a game.
It’s honestly pretty simple to come up with the equation to see if this makes sense, but so often it was something that sounded very foreign when discussing with borrowers. Easiest way to go about it is finding out how many months that you’d have to be saving that $30 for it to equal the amount that you’d be paying up front for the lower rate. Therefore, if you’re paying $3,500 for the rate, you would have to pay that mortgage for 116 months at that rate for the savings to be worth it. In this day and age, unless it’s your dream home that you plan on building your family around or holding on to as an investment down the line, that’s a really long time to keep the same home, even less to not refinance in a few years. A lot of the time, it ends up making more sense to take the par rate at what it is. This saves you cost upfront, and will honestly make it easier to refinance in a few years depending on how rates are looking in the future.
In such a fast-paced, ever equity-increasing market that we’re in, I think it’s really important to keep as much cash in your pocket as possible throughout the home buying process. Home ownership comes with a lot of really good benefits, but can also have some unexpected costs if you’re looking to do any type of renovation after you purchase. If you are dead-set on taking that lower rate and paying for it, you might be setting yourself up to be short funds unnecessarily. My opinion is, keep the money in pocket if at all possible and use it to make upgrades or something else to enhance your home after you buy it to make it more your own.