NestEgg Home Buying: Bay Area Real Estate

Mortgage Rates: What to Expect, Where to Find

As the model shows in my post on "running the numbers" ("link to Running the numbers"),  the mortgage rate you can get will greatly influence what you can afford and the attractiveness of buying. 

How do you find out what rate you can get?

When you're considering buying a house, the best proxy for a reasonable rate is Etrade's online mortgage pricing (link to etrade mortgages).  To be realistic, add 1/2 to 1/4 point to the rates you see online. This will give you a sense of what to put in the model

How do you find the best rate when you're ready to buy?

The best rate we found was through a mortgage broker.  Initially we thought a bank would give us a better rate because there wouldn't be a middle man to take a commission.  We were wrong. The bank branch effectively acts as a middle man and recieves a commission from the corporate bank.  In fact, Bofa and Wells Fargo were generally much higher than our mortgage broker.  Things to look for in a broker:

-Low overhead:  If the guy works out of his house, all the better--lower overhead, means he'll accept a smaller commission/ spread and thus you'll get a better rate.  Just make sure you know someone has worked with him before

-High volume: Lenders will actually give lower rates to brokers that deliver a lot of volume

What Product Type?

Brokers will have better rates on certain types of loans (e.g. 5 year ARM).  The brokers will tend to steer you to these types.  If this type of loan isn't what you're interested in, you should check with other brokers for your desired loan--you'll probably find a better rate.

To find out the best product type for you, we've created an analysis on the different loans (link)

What to Look for in A Loan

There's a lot understanding what is the right loan for you.  First, you should absolutely make sure that there is no-pre-payment penalty on your mortgage.  If miraculously interests drop or you need to sell your house earlier than expected, than these fees will kill you.  Some other issues to think through:

Fixed vs. Adjustable:

Most people signup for a long loan out of default.  Making the right choice on the length of the fixed period is dependent on:

1) how long you're planning to stay in your house: if you're moving in 5-10 years, why pay higher rates for a 30 year fixed?

2) your view on interest rates: If you think interest rates are going to decrease (not likely), than a shorter term fixed loan is good because you will refinance anyway.  If you think rates will increase, and depending on the answer to #1, a longer fixed period might make sense

3) Commonness:  For some reason, 3/1, 5/1 and 30 year fixed loans are most common in the Bay Area and prices are lower because of the competition.  Whereas 7/1, 10/1, and 15/1  are more uncommon and thus you pay a disproportionate premium

Take a look at our analysis: Fixed vs. Adjustable Mortgages--Running the Numbers (link)

Points

Points are like paying a fee for a lower interest rate.  Whether it makes sense to do this depends on #1 and #2 listed above and the length of your fixed period.

The only complication is that points can be deducted in the current tax year.  Thus, if you have a spike of income and need immediate deductions, then taking points and a lower interest rate may be more attractive.

Fixed vs. Adjustable Mortgage--Running the Numbers

Should I lock-in the low interest rates with a long term fixed rate mortgage?  Or should I take a lower cost 3 year or 5 year adjustable mortgage rate?  It all depends.  It depends primarily on how long you plan to be in the house (or refinance your loan), and it depends on what your view on the future mortgage rates to be. 

To help you decide, I've put together a mortgage interest estimate spreadsheet.  Assumptions are in blue.  To use this spreadsheet, populate the current rates on the different mortgage products by going to the following link.  In terms of the floating rate, most loans are based off a spread + LIBOR. I estimated this "floating rate" by assuming that the FED was going to continue to raise rates at 1/4 point each quarter, or 1 point a year (see mortgage watch link) for a couple years before the rate leveled out at 7% going forward. 

The lowest or least expensive mortgage is highlighted in bold with a yellow background.  Note that products such as the 7 year adjustable are never the least expensive product for this case of assumptions. 

Click to download the spreadsheet here: Download mortgage_interest_estimator.xls