Why a Lower Interest Rate Might Not Make Your Mortgage Cheaper

The amount of money you borrow to finance a home purchase is obviously the key factor in how much your mortgage payments will be. But your interest rate will also play an important role in how expensive your overall mortgage will be.

Obviously, a lower interest rate will translate in lower interest being paid, while high rates will make the overall loan amount more expensive.

But the interest rate that you’re charged isn’t the only factor that will influence the overall cost of your mortgage. In fact, it’s possible for some mortgages with lower interest rates to be even more expensive than those with a higher rate.

How is this possible?

In addition to the interest rate, there are plenty of other fees associated with mortgages that borrowers need to get familiar with in order to understand the exact cost of one mortgage product compared to another.

Shopping for mortgages is definitely a good idea to help you compare different mortgages, but interest rates aren’t the only factors to consider. There are other fees involved that should be considered when choosing a specific mortgage.

Penalty Fees

Mortgages come with rules that borrowers need to adhere to in order to avoid paying any penalty fees. Otherwise, additional costs can be tacked on, making the mortgage more expensive despite a lower interest rate.

For instance, just about every mortgage product charges penalty fees if borrowers break their mortgage early. Borrowers who take out a mortgage may have had no intentions of breaking their mortgage early when they first apply, but life can throw curve balls that may change circumstances.

Job loss, job relocation, divorce, medical issues, and a death in the family can all change the course of life for many homeowners. In these cases, an unexpected move may be required, which would require the mortgage to be broken before its expiry date. When this happens, a penalty fee will be charged.

Generally speaking, adjustable-rate mortgages often come with penalty fees of three months’ worth of interest, while penalty fees for fixed-rate mortgages could be whatever the lender deems to have lost in interest as a result of you breaking the mortgage early. You’d be well advised to speak with your mortgage broker to find out exactly how much this is.

Mortgage Term

Your mortgage term can make a difference in how much you pay in total. For instance, if you take a one-year term in order to take advantage of a lower interest rate than a five-year term, you could really save quite a bit of money. But if rates increase after that year is up and you have to renew your mortgage with a new term, you’ll be spending more.

On the other hand, you could go with a five-year fixed rate in order to take advantage of the security of predictable payments. But if rates fall soon after, you’ll be paying more than you would have if you chose a shorter term.

Loan Origination Fees

Mortgage brokers get paid commissions for the services they provide. These “loan origination fees” usually work out to be about 1% of the mortgage amount and are paid by the borrower.

However, mortgage brokers can negotiate no-cost loans in order for borrowers to avoid having to pay these fees upfront and to make these fees the responsibility of the lender to pay when the deal closes. But this scenario will almost always translate into a higher interest rate, which will end up costing you more over time.

Application Fees

There is a cost associated with actually applying for a mortgage. These administrative costs will be factored into your overall loan amount.

Appraisal Fees

Lenders require that homes they supply mortgages for are appraised by a professional in order to ensure that the property is worth at least as much as what the buyer agreed to pay for it. But there’s a fee associated with appraisals, which can range from anywhere between $400 to $600 and more, depending on the scope of the property.

Private Mortgage Insurance

If you put less than a 20% down payment towards the purchase price of your home, you’ll have to pay private mortgage insurance (PMI). This premium will be added to your monthly mortgage payment amounts and will make your overall mortgage more expensive.

The purpose of PMI is to protect the lender in case you default on your mortgage at some point. The higher the loan-to-value ratio – which is the loan amount relative to the value of the property purchased – the higher the risk associated with the mortgage. In order to mitigate this risk, lenders require PMI premiums on top of mortgage payments.

The actual amount you have to pay will vary depending on the exact circumstances of your mortgage, but PMI can cost anywhere between 0.5% to as much as 5% of the loan amount and is paid annually. That means a $200,000 loan amount at a 1% premium, for instance, would cost you $2,000 per year (or about $167 per month).

The Bottom Line

Your interest rate and the loan amount are definitely key factors in the overall cost of your mortgage. But there are several other costs that you will need to consider in order to get a clear picture of precisely how much you owe. Be sure to speak with a mortgage broker to help you compare mortgage products and calculate the exact cost of the home loan you ultimately choose.