Once you begin home shopping you will see advertisements from dozens of lenders promoting the super low interest rates that they can get you. These “teaser” rates are very effective way to reach borrowers but the odds are slim that you will actually end up with one.
Teasers are rare in real life
Teaser rates are actual rates, but they are rates available only to the very best borrows under ideal conditions. Mortgage rates change constantly—sometimes several times a day– to reflect the cost of money to lender, like the way the price of gasoline at the pump changes with the cost the gasoline to the retailer. Location, the availability of credit and the size and type of lender also affect the rate borrowers will pay.
Borrowers and the loans they select have a huge impact on the rates they will pay. Lenders charge higher rates reflecting the risk they take. Longer loans incur more risk, so 30-year mortgages have higher rates than 15-year mortgages. “Conforming” loans that can be sold to Freddie Mac or Fannie Mae incur less risk and have lower interest rates than non-conforming loans like jumbo loans or loans that don’t meet the standards of the GSEs.
Your credit is more important than their teasers
But biggest factor determining the interest rate you will pay has nothing to do with the teaser rates you see advertised or the kind of loan you take out. The biggest factor impacting your interest rate is your credit score.
For example, on a 30-year fixed rate mortgage, the APR for a borrower with a credit score between 640 and 659 would be 4.526%. But borrowers with credit scores just 20 points higher, 660 to 679, would get a lower rate, 4.096%, a decline of half a percentage point. (These calculations are from the MyFICO.com site based on a $150,000 loan on a single family, owner-occupied property type and an 80% (60-80%) Loan-to-Value Ratio.)
Bear in mind that these are averages. Most lenders today practice tiered pricing, with interest rates rising as scores go down. Each lender chooses its own “break points” between tiers. Lender A may bump up the interest rate if a score falls below 700, while Lender B doesn’t charge higher rates until the score is 690 or below. So if you stick with one lender, and that lender’s break point is 700, raising your score from 698 to 701 can be vital.
That difference in 20 points would amount to a monthly payment of $724 versus $762 or $142,253 versus $124,446 in interest over the life of the loan. That’s a savings of $17,807. That half a point of interest that you would save is probably more than you would probably save by shopping for teaser rates
Your mortgage will probably be the biggest debt you will ever incur. Shop hard. Look for a reputable lender with good customer service and solid financial credentials. Think about what kind of lender you would like to do business with—traditional bank, online lender, credit union? Shop thoroughly and consider teaser rates.