Mortgage rates can be pretty confusing, particularly if you’re a first-time home buyer being overwhelmed with “lowest rates available.” It doesn’t seem to help that many lenders use misleading marketing tactics! Do you wonder how loan officers even come up with those numbers that make up your mortgage quote? In this episode of Mortgage Secrets, John Downs of The Downs Group at MVB Mortgage breaks down what all goes into a mortgage loan rate, why the best available rate on a given day may not be as significant as you think, and how choosing the best loan product (like anything else in the home-buying process) really comes down to what your life goals are.
In this episode of Mortgage Secrets, we’re going to talk about what everyone wants to talk about: Rates. This is Mortgage Secrets Episode 7, and I’m John Downs.
If you’re shopping for rates, it’s important to try figuring out how they are derived.
Where do they come from? How do we pick them? Interest rates are tied directly to a combination of so many factors, but usually, you start with a product set at some point, and this product might be derived from a combination of your credit score, your down payment, and price point.
And then, of course, you can spin off, and within that product set, you can talk about fixed rates. With fixed rates, of course, you’re borrowing money, there’s an interest rate, there’s a period of time, and at the end of that period of time, the mortgage is gone. In a 30-year fixed-rate, you make that payment for 30 years, and the mortgage is gone. You could also have a 10-year, a 15-year, or a 20-year. Of course, those payments are higher.
And then the other side is adjustable-rate mortgages. I know a lot of people say adjustable rates are bad, but I believe there are many situations where it makes good sense. It just depends on your goals personally. You’ll hear lenders say things like 3-year, 5-year, 7-year, 5/5, 10-year, 15/15. There are all kinds of different ways of doing adjustable rates. Generally speaking, that first number you hear is the period of time in which nothing ever changes. That second number is usually how often it changes after that. A 3/1 is fixed for 3 years and adjusts every 1 year thereafter. A 5/5 is fixed for 5 years and adjusts every 5 years after.
Both fixed and adjustable live within an actual product set that you have to determine first.
Let’s talk about those product sets because, ultimately, you can’t work on that rate until you have that pegged. When you think about the loans that exist out there, they can kind of be put into different buckets. You would get conventional loans (think Fannie Mae and Freddie Mac). You have government-type loans (FHA, VA). You have private loans. You have jumbo mortgages. You have second mortgages.
They’re all operated a little bit differently. On the conventional loan side, that’s where probably most of the buyers try to go and fit into. The underwriting standards are a little bit relaxed. The rates are a little bit better. The mortgage insurance, if you need it, is a little bit more cost-effective. But again, a lot of people would default to FHA and, in some cases, jumbo finance.
I get this question quite a bit about FHA: “I hear that’s a dirty word; I hear that’s a bad loan—what exactly is it?”
Of course, in some way, shape, or form, the government is kind of involved in mortgage lending. On the FHA side, it’s a product designed for people specifically with low down payments. Although there are some components of it that can be a little expensive in the form of either monthly mortgage insurance or this up-front insurance that they actually roll into your loan amount, it can still be a great tool to help people get into housing earlier in life. I think everyone just needs to look exactly at what those costs are to see if it fits into their goals and plans and works out. It’s a great loan. It has a bad stigma in the market, but it’s quite useful.
Now, choosing a product is a different story because, again, it starts with you.
When we go through this goals conversation, and we have an idea of how much cash you have available, I think that’s the primary driver in choosing what product to go with. Income and credit score—all that is a piece. Your debt is a piece. But generally speaking, the down payment that you have will, ultimately, lead us down the path of choosing which is best.
Again, “best” means “least expensive for you.” “Best” could also mean “easiest to use and navigate your housing market.” There are some loans that just move slower, and there are some loans you can do really fast. There are some loans that use digital technology, where you can close virtually yesterday, and others that just pull you through the ringer, and it takes some time. Again, down payment is a big piece, and then the market that you’re in is the other.
I’ve been in the business since 2001, and I think the same conversation can be had if you go to your parents and your grandparents. Everyone would probably tell you the story: “When I was your age, rates were 18%.” Well, when I started, rates were at 8.5%. The way I explain the interest rate market (and this is somewhat globally) is just imagine playing with a yo-yo while going down an escalator. There are upward and downward movements, but the general direction has been lower.
There are always different ideas and methodologies of people saying, “Well, rates will never be this low again; rates are going to rise steadily over time.” There are others that you can look at as an example, like Japan. They’ve had low rates for 20-something years—and much lower than ours. It’s hard to peg exactly where rates are going, and that’s why, usually, you just look at the corresponding payment and everything that goes with it to figure out if you should buy.
Generally speaking, I don’t think anyone out there should buy a property specifically because of a rate.
There are lots of reasons and examples that I have. I remember, in 2013, interest rates went from 3.5% all the way up to about 4.75%. They called that the “taper tantrum.” That was back when Ben Bernanke sort of whipped out this idea that maybe one day we’re going to start withdrawing some of this stimulus, maybe, maybe… And, of course, the markets just sold off dramatically. Throughout that entire period, as rates were pushing higher, people started making some crazy offers. I remember them saying, “I’m just afraid rates are rising.”
Then you fast forward 8 months after that point, and rates were lower. You fast forward 3 years later to 2016 when we touched all-time lows again—lower than they were in 2012. You buy a property based on your goals, the timing, and the corresponding payment, and then you understand, if rates drop in the future, you can restructure that debt, but I don’t think you should rush into the market specifically to buy a specific property that might not be perfect just because of this rate that you see. So, the key here is to buy when you’re ready to buy, and buy what’s right for you and your goals.
Once you’ve assigned the product, and you’ve kind of figured out your down payment (although you don’t have to have this down payment pegged but maybe a range), and then you start looking exactly at the rate.
“What is your rate today?” is exactly how the question is phrased. So, when people say “the rate,” know that there isn’t just this one rate.
If I look at my rate sheet today (here we are shooting in July 2017), my interest rates on conventional loans go from 3.5% all the way up to 5.5%. Somewhere in the middle, there is this rate that doesn’t really cost you anything. You’re not paying for the rate. It’s just the rate that you get. When you go lower in those interest rates, that’s actually where the lender will say, “You need to pay extra to get this lower rate.” They call that “points,” percentages of your loan amount in the form of a monetary cost, the dollar amount.
The inverse of that is what if you took a higher rate? The neat thing about regulation today is lenders cannot keep extra profit in mortgages, so if you choose an interest rate that actually has extra profit, that money has to be reallocated to the consumer. The term is just “lender credits.” It’s the inverse of buying the rate down. It’s choosing to take a higher interest rate in exchange for a big lender credit.
We’ve got a great video in our resource section at DownsCapital.com about this very topic that you should check out. I would say that 30% of the loans that I use for first-time homebuyers, generally, include this feature. If someone doesn’t spend the time to try to unpack their transaction, and all they talk about is the rate that day, they miss entirely this lender credit conversation and, ultimately, could cost themselves lots of money. Taking time to unpack not just the rate and spending time to look at the entire spread of rates…
When I say “spend the time,” that means conversation. That means analyzing multiple estimates. That means follow-up conversations to make sure that you understood all those things. That’s what we mean by “relationship.” Take the time to dig a little bit deeper and fully educate to the possibilities.
Now, when we counsel clients on how to choose the multiple structures, it can be a little complicated.
Ultimately, we always wind up showing… It never seems to be less than three. I think if someone is putting less than 20% down, there’s always at least two. There’s a loan with mortgage insurance and without, and those rates are different, and those payments are different. But then when you sprinkle in lender credits and the possibility of maybe a lower or larger down payment, that could lead to another two to four more options. It takes time to prepare the quotes. It takes time to analyze them. It takes time to unpack all the tax savings, so you can really get a holistic approach, but I find, after we go through that exercise, everyone has tremendous confidence in the direction that they’re going, but I believe that confidence only exists because of the corresponding education that goes with it.
Now, let me just go a little bit deeper on the lender credit idea.
Lender credits, typically, can be up to 3% of your loan amount. Let’s assume you’re buying a property, and your loan amount is $400,000. Let’s assume the prevailing rate is 4%, just to be easy. If you take a rate of 4.75% or 4.8%, something like that, the lender will give you a 3-point credit. It’s not always exactly like that, but that’s just a general idea.
Then the conversation is “Do I want to take that $12,000 of cash today in exchange for paying a little bit more per month over time, knowing that that higher interest rate also yields tax savings, also knowing that over time I could restructure the debt through refinancing?” Again, it’s a big conversation that takes some time to unpack.
Now, our industry is also drawn to flashing the lowest possible rate that’s out there in probably one of the more confusing ways.
“Fixed rates as low as 3.1%.” Then you call, and you realize it’s a 15-year loan with 2 points. Generally speaking, I’m not a big points kind of guy. Points are where you pay the lender money up front in exchange for a better interest rate. Why don’t I like that?
There was a gentleman in 2009, I believe, had a $600,000 loan. He chose to pay 3 points—that’s $18,000 ($600,000 x 3% = $18,000)—to get a 4.5% rate. Six months later, we were doing no-cost refinances at 4%, and when we called him out of the blue to say, “Hey, good news—we can lower your payment and your rate,” he kind of chuckled and said, “You know, I kind of wasted all that money a few months ago, didn’t I?” That answer was very clearly yes.
I think points work on smaller loans. They work when, let’s say, you know you’re working now, but you know you won’t be working in the future—retirees and things like that—where you’re just going to lock in that low rate forever and ever and ever. There are instances where points make sense. I think you just always need to look at the economics to understand it fully.
One key thing to know is that, depending on where you are in the home buying process… I know everyone is always focused on rate, and a lot of times, they choose the lender based on that rate, but yet they’re not even under contract for a house. It’s important to know that rates change every day. I sit on my hands, pins and needles, every day at 10:30ish, waiting for rates to come out. The markets start trading in the bond world at about 8 AM, so you kind of have an idea of where things are trending, and you, usually, will get a rate sheet at 10:30, and then you could get another one at 1:30 and another one at 4.
If rates can change three times a day, they can certainly change over many months.
It’s important when you’re shopping rate, when you’re trying to prepare for a purchase, the question is always “What rate are you using? Are you using a rate today? Are you forecasting an increase? Is the lender using a rate that’s arbitrarily a little lower just to keep you engaged and using them because ‘they had the best rate at that time?’” Know that rates do change every day, and that needs to be a part of your forecast if you’re out shopping.
The key takeaway here is to know that there isn’t just this one rate. There are probably many rates, and in order to get it, we need to know about you:
How can you structure this transaction?
What is your down payment?
Are lender credits right for you or not?
Are adjustable rates right for you or not?
And when are you buying, and what do we think interest rates are going to do between now and then, so you can properly budget?
It’s a much bigger conversation. It’s way bigger than “What is your rate today?” If you want to learn more, download my companion e-book to this podcast at DownsCapital.com/shop, or email us at info@DownsCapital.com. Thanks so much for listening. I’m John Downs.
Special thanks to everyone who joined us. Until next time! Share your thoughts!
Leave a note in the comment section below.
Share this show on Twitter or Facebook.
I’m happy to answer your questions. Fill out the form to get answers!