Is A Low Interest Rate Loan In Your Best Interest?

by : Jeffrey Nelson

The rule of thumb is to always try to get the lowest interest rate, right? Well, while it makes sense to get as low an interest rate as possible on a home loan, there may be some good reasons to avoid going to extremes to get an all-time low rate.

Some people opt to pay points to get a lower mortgage rate. A point is calculated as 1 percentage point of the loan amount, so on a $200,000 mortgage, a point is $2000. Typically paying a point will have the effect of lowering the interest rate by a quarter percent (this varies with different lenders). So to lower interest from 6.5% to 6%, you would pay two points, or in our example, an extra $4,000.

There are several other loan options for buyers that want to have a lower interest rate. One option is an adjustable rate loan, which has a lower interest rate initially, but may increase over the life of the loan along with national rates.

All of the interest lowering options have a cost associated with them, either an upfront cost such as paying points at closing, or a delayed cost, such as a higher long-term interest rate over time.

When it comes to deciding whether it is worth pursuing a lower interest rate, think about the value you receive from paying interest. What??? Well, as much as we hate paying interest, there is one compelling reason for paying it, you can take a yearly tax deduction for your mortgage interest.

Consider our example, if you have a mortgage of $200,000 and are paying 6.5%, your monthly payment is $1,264.14, and your interest paid for the first year is $12934.18. Now, if you take that same $200,000 and pay 6.0%, your monthly payment is $1,199.10 and your first year interest is $11,933.19.

The lower interest rate means you will pay $65.04 less per month ($780.48 less for the year). If you paid $4,000 in points it will take you slightly over 5 years to recoup your money in payment savings.

Your tax deduction will be less as well. Your deduction will be $1000 lower than it would have with the higher interest rate. So, in addition to the out-of-pocket cost of points, you also lose out on some of your potential deduction.

Of course, over the life of the loan you pay less a lot less interest with the lower amount. When you consider whether you want to pay for a lower interest rate you need to consider a number of factors: how long will you been in the home; do you want a lower payment; or do you want to save money each month by paying less taxes? It is all about your priorities and what works best for you. In the end, you have a vested interest in interest. Take time to carefully consider your options.