When Does a Higher Rate Mortgage Mean Lower Monthly Payments?

You found a house, and you made an offer. The offer is accepted, and you’re excited! You agree on a purchase price of $300,000, and you’re able to put 3% down. That means you need a mortgage for $291,000. Now you’re ready to apply for a mortgage.
Have many of you will look for the mortgage with the lowest rate and lowest fees? (I bet YOUR hand went up!) Have you ever thought that maybe - just maybe - you can get a higher rate mortgage and pay LESS per month?

Let me explain the situation. First, I’m talking about comparing 30 fixed rate mortgages. I’m not talking about adjustable rate mortgages, Option ARMs (Pick-A-Payment Loans), 3-2-1 Buydowns, 2-1 Buydowns, or interest only mortgages.

To make sure that we’re all on the same track, I’m going to compare three different fully amortizing 30-year fixed rate mortgage programs for a loan amount of $291,000. This is just 3% down on a purchase price of $300,000.

We’re all on the same track? Good! Now let me ask this question: Which program will result in the lowest overall monthly payment:

1. A 30-year fixed rate mortgage at 6.5% with PMI; 2. A 30-year fixed rate mortgage at 6.875% with Lender Paid PMI; or 3. A 30-year fixed rate FHA mortgage at 6.25% with MIP?

(Note: PMI = private mortgage insurance. MIP = monthly insurance premium)
Did you pick program #1? Or did you pick program #3? (I bet none of you picked program #2!)

Let’s break them down one by one:
1) A 30-year fixed rate mortgage at 6.5% with PMI
If you select this mortgage, your monthly mortgage payment will be $2091.52. You will pay $1839.32/mo for principal and interest, and $252.20/mo for mortgage insurance.
2) A 30-year fixed rate mortgage at 6.875% with LPMI
If you select this mortgage, your monthly mortgage payment will be $1911.66. The lender will pay the mortgage insurance premium, so your total mortgage payment will be $1911.66/mo for principal and interest.
3) A 30-year fixed rate FHA mortgage at 6.25% with MIP

If you select this mortgage, your monthly mortgage payment will be $1941.68. With FHA mortgages, there is an upfront mortgage insurance premium of 1.5%. You can roll that into the loan, which I did in this case. So, your initial loan amount will be $295,365. Your monthly mortgage payment will be $1818.61. You will also pay a reduced mortgage insurance premium of $123.07/mo.

Result
As you can see in this case, Option 2, or the mortgage with the HIGHEST interest rate, will actually result in the LOWEST monthly mortgage payment. In this case, you will save $179.86 month in payments compared to the conventional mortgage with PMI. You will save a total of $2158.32/year. That’s 1 mortgage payment per year! You will save more than $10,790 in payments over 5 years.
If you have lower credit scores (less than 680), you may want to consider the FHA option (Option 3). Even though you have the upfront MIP, your overall monthly payment will be just a little higher than the conventional mortgage with PMI (Option 1) because the interest rate is less, and the monthly MIP is less. In this case, you will save $149.84 month in payments compared to the conventional mortgage with PMI (Option 1), for a total of $1798.08/year. That’s about 1 mortgage payment per year! You will save more than $8,990 in payments over 5 years.

Now, some people will say over the course of 30 years, the higher interest rate mortgage will result in more payments. That’s true. It will. But, how many people will stay in their current mortgage over the course of 30 years? Not many. Most people will refinance or sell their current home and buy another in 4 - 7 years.

Others will say that when the principal balance of the existing mortgage is less than 78% of the original balance of the note, the PMI has to be eliminated by law. That’s also true. But, do you know how long it will take to get to that point? It will take 157 months. That’s more than 13 years! Can you wait that long?

Finally, others say that when you can show at least 20% equity in the home, you can apply to the lender for the removal of PMI. That’s also true. Let me ask you this: How long will it take in today’s real estate market for your house to increase in value while at the same time your principal balance drops to the point where you will have 20% equity? 2 years? 5 years? 10 years? If houses appreciate at a rate of 3% per year (which, by the way, is NOT happening in most areas today), it will take you 5 years in this case to see 20% equity in your house. Your house will have to be worth at least $341,000 in 5 years as your remaining mortgage principal balance will be $272,770. Hmmm. Do you want to take that chance?

Conclusion
When comparing mortgages, don’t just shop rates. Also compare the total monthly mortgage payments on the loan programs both with PMI and without PMI. Also compare both programs with the FHA program to see which will result in the lowest overall monthly payment. And be sure to weigh all options before selecting the mortgage program that’s right for you. I sincerely hope these tips and ideas are of value to you. For more information about mortgages, or if there is any way I can be of service, please don’t hesitate to give me a call. I’d consider it a privilege to be of service to you!

Warmly Yours,

Lew Corcoran

Sr. Mortgage Consultant

http://www.LewCorcoran.com

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