Which is best? Lowest Interest Rate, or Lowest Closing Costs?

When buying or refinancing a home, what is best, getting the lowest interest rate, or the lowest closing costs?

I know what you are saying - Getting both the lowest interest rate AND the lowest closing costs would be best, but shop till you drop, you can't get both!

First, we need to do a little background on both interest rates and closing costs.  I'll start with simply explaining that for all intense and purpose, ALL LENDERS get their daily rates from the same bond market everyday, and that all lenders have basically the same closing costs. Most of your closing costs are not lender related costs, but rather, third party fees that lenders disclosue, collect, and then pay to the other person or party. This includes appraisal, credit report, title company, state deed taxes, pro-rated proerty taxes, and even your first years home owner insurance.

Realistically then, all lenders have the exact same wholesale cost in aquiring the loan. There are only two real differences:

1) Overhead. The markup they need to make a profit and pay overhead.

2) Marketing strategy. Do they advertise low rates, or focus on low costs to capture your attention

The more overhead, the higher their rate needs to be.  Because of this, the simple truth is the more they advertise, the more physical locations they have, and all those stadium naming rights have to be paid by someone, and that someone is always you.  So in most cases, picking a non-bank broker is almost always your best deal, simply because they don't have all that overhead.

Marketing stategy. Many people incorrectly only focus one item, either on low rates, or low costs. So by adjusting their advertising to fit one of those groups, they can capture a deal from another lender who maybe advertise the opposite way.

INTEREST RATES AND CLOSING COSTS GO HAND IN HAND

A common mistake shoppers make is to ask: "What's your best rate?" or "What are your closing costs?" Both logical questions to ask, but they do not give the response most borrowers need to make a proper decision. Borrowers must understand both rates and fees. Rates are only half the answer to getting the best deal. It is possible end up with the lowest rate, or with low or no closing costs, but not necessarily the best deal.

I can give you a rock bottom rate quote, but it will cost you in higher closing costs and discount points to 'buy' down the rate from the real market rate. But you got a low rate!

I can give you lower closing costs, and even say things like a 'free appraisal', or claim I never charge loan origination fees. But you got low closing costs.

I always love the 'no origination' claim... They work for free huh?  :)  You are smarter than that.

SO HOW DOES IT WORK?

The combination of rate & fees can be very confusing. One lender is screaming "No origination fee" and a 4.25% interest rate. A second lender may quote you 4.0% with $7904 in costs, while another lender is offering 3.75% with $10,904 in costs. How do you decide which one is best?

The is rather simple.  You just need to figure out what is best for you, then pick an interest rate and closing cost combination that works best for you

Here is an example of Rate vs. Costs on a $300,000 - 30 year fixed loan In Minnesota

This is based off just the first 5-years. As time goes by, the low rate option will gain significantly in benefit over the low cost option. But, you needed significanly more money in closing costs today.

So are closing costs and fees bad? Are lower cost loans good or bad? Well if you ask everyone's brother who knows everything about mortgages, then you'll usually here just their misguided personal opinion, which may or may not have any bearing on your situation.

 EVERYONE IS DIFFERENT

If you have the extra money for higher closing costs today, and you plan on being in the house at least 5-years, getting the lowest interest rate is smart. On the other hand, if you are struggling just to come up with the down payment, and only think you'll be in the house five to seven years, the lower cost, higher interest rate version may be a great choice for you.

Don't let the Loan Officer dictate what is best for you, be sure to ask about different interest rate and closing cost combinations. Don't assume one is better than the other without doing math.

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Joe Metzler is a Senior Mortgage Loan Officer for Minnesota based Mortgages Unlimited. He was named the 2014 Minnesota Loan Officer of the Year, and Top 300 Loan Officers in the Nation for 2010, 2015, 2016.  He provides Home Mortgage Loans in MN, WI, and SD. He can be reached at (651) 552-3681. NMLS 274132.