When you're in the process of buying a home, securing the right mortgage is a crucial step. Many home buyers may not realize that once a rate is locked in, they don't just have a single interest rate option. Instead, there is a rate stack—a list of interest rates to choose from, depending on whether you want to receive a lender's credit in return for a higher interest rate, or pay additional money (or points) at closing to lower the interest rate. There is also a "par rate", which is the middle rate on the rate stack which typically has either zero or a minimal lender's credit, OR zero or minimal points.
Understanding Rate Stacks
A rate stack is essentially a menu of interest rates available to you, each with different costs or credits associated. Here's how it works:
- Lender Credits: Choosing a higher interest rate can earn you lender credits, which can help cover closing costs.
- Discount Points: Opting for a lower interest rate may require you to pay additional upfront costs, known as discount points.
The Flexibility of Rate Stacks
When you lock in a mortgage rate, your lender provides you with a rate stack, allowing you to select the rate that best fits your financial situation and long-term goals. Here are some scenarios:
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Choosing a Higher Rate with Lender Credits:
- Scenario: You prefer to minimize your out-of-pocket expenses at closing.
- Benefit: Lender credits can cover closing costs, reducing your initial expenditure.
- Consideration: While your monthly payment might be slightly higher, the upfront savings can be significant.
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Choosing a Lower Rate with Discount Points:
- Scenario: You plan to stay in your home for a long time and want the lowest possible monthly payment.
- Benefit: Paying points upfront reduces your interest rate, leading to lower monthly payments over the life of the loan.
- Consideration: You'll need to have extra funds available at closing to pay for the points.
How to Choose the Right Interest Rate
Selecting the best interest rate from a rate stack involves evaluating your current financial situation, future plans, and how long you intend to stay in the home. Here are some tips:
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Evaluate Your Budget:
- Consider how much cash you have available for closing costs.
- Determine whether you can afford to pay for discount points upfront.
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Calculate the Break-Even Point:
- The break-even point is when the savings from a lower interest rate offset the cost of paying points.
- If you plan to stay in your home beyond this point, paying points can be advantageous.
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Long-Term Plans:
- If you plan to sell or refinance within a few years, opting for lender credits might make more sense.
- For those planning to stay put for a longer period, paying for a lower rate could lead to substantial savings over time.
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Consult Your Lender:
- Your lender can help you run the numbers and compare different scenarios.
- They can provide insights based on your unique financial situation and goals.
A Practical Example
The question to ask oneself is, “How soon will the next refinance most likely occur?.” If you plan to refinance within the next year, you may want to select a lower interest rate by paying points up front. The average consumer would need to grab a point lower than their current mortgage rate in order to be cost-effective.
If you purchase a home for $500,000 and your interest rate is 5.2%, then you will pay $1,000,000 for that house over the course of 30 years. If your interest rate is 2.5%, then your total cost for the same home will be $750,000.
You can see a sort of harmonic scale in musical terms. Specifically, the relationship between interest rates and payments. For my guitarist friends, a 5.2% interest rate is like a 12th fret harmonic, and a 2.5% interest rate is either an 8th or a 16th fret harmonic.
Timing is Everything
Historically, in the mortgage industry, January and February offer the lowest rates, so we know that the next opportunity will most likely be January or February 2025. Since we know the most likely time to refinance will be in about six months, why would we overpay for a golden percentage interest rate when it’s highly likely that it will be par in six months?
My advice to you is this simple principle: Pay the premium on a high or low interest rate, but in between the top and bottom, pay par and save a gold bar.
How Armenta Realty Can Help
David Armenta is a BiggerPockets nationwide lender, and real estate broker in California and Arizona. He is here to help you make the best decision considering your personal circumstances. At Armenta Realty, we offer a variety of mortgage products across most states in the US. Our team of experienced professionals is ready to guide you through the process and find the best rates available.
Contact David Armenta at [email protected] to discuss your refinancing options and start saving today.
