How to Save 35% on the Total Cost of Your Home
Stand back, all my darling practical piggies, because I’m going to do math for you again and it’s going to be fabulous.
Today’s delicious math is performed with the end goal of explaining why you really do need to shop around for your mortgage, and why you need to do so before you start shopping for a home with a Realtor.
See, if you’re buying a home and I’m representing you, my job is to negotiate the lowest possible price. We Realtors do pretty well at the whole negotiation thing. According to MRED’s MLS, the final sale prices of homes in Chicago over the past year have been about 10% less than their final list prices. 10% is nice. I got 25% off for one of my buyers this year and felt pretty darned pleased with myself for doing so, but it was a special & extreme circumstance.
But the true cost of a home isn’t just the purchase price. What about the closing costs and interest payments that you’ll rack up over the life of your loan? Unless you’re paying cash only, you’re going to be paying out quite a bit more for the privilege of borrowing someone else’s money. I do everything I can to get you the lowest purchase price, but how much you actually pay? That’s up to you.
By planning ahead, saving a good down payment and working the details of your mortgage you could save 9% on the total money spent after just 5 years in your home. By year 10 that savings is up to 21%. If you stayed in the home for the full life of the loan you would save 35%. That’s more than you’d save in any sort of negotiations over the actual purchase price, and definitely more than the piddly 2.5 to 3% you’d purportedly save on just the purchase price by going without an agent at all.
The Savings are Independent of the Price of the Home.
I’ve run the numbers, I’ve checked it at different price points – as long as you’re looking for a regular sized loan (e.g., less than the current 2012 “jumbo” loan cutoff of $417k), your loan variables will have a far greater impact on the cost of ownership, and the savings are consistent all the way up the price chart.
Wait… What are Discount Points?
When you’re shopping for a mortgage and your lender offers you a higher interest rate than the best available, you may be able to pay extra money at closing in addition to your down payment in order to lower your interest rate. Each additional percentage point of your loan that you pay at closing will lower your overall interest rate by a set amount. These percentage points are referred to by mortgage lenders as “discount points.” You could conceivably pay up to 4 points.
For the sake of this study I’ve used a ballpark figure that each discount point paid at closing will lower your interest rate by 0.25%. (This number is quoted by both Moving.com and Bankrate.com as a reasonable expectation.)
Our Case Studies
For today’s three model homes I’ve checked the MLS for the median prices paid over the past three months. Our models will be:
- An Edgewater 2 bed, 2 bath condo (median: $179,750)
- A Jefferson Park Single family home of any size (median: $226,500)
- A Lincoln Park 3 bed, 2 bath condo (median: $439,750)
I assumed that our buyer had pretty weak credit and would have to pay the full 4 discount points to get his interest rate down to the current national average for a fixed-rate mortage.
Because I needed some givens, I assumed he would have to pay 3.5% over the sale price in closing costs in addition to discount points, and that moving costs would be about 0.5% of the sale price.
In terms of interest rates I took the current national averages shown on Bankrate.com as my starting point for the “best possible rate.” That was 3.58% for a 30 year fixed rate mortgage and 2.98% for a 15 year fixed.
For each of these scenarios I considered down payments of 5%, 10%, 15% and 20%. (For the Lincoln Park condo I fudged the lowest down payment to 5.2% to keep it under the “Jumbo” cutoff.) I considered how the values would change if the buyer paid all 4 discount points to get his rate down to the national average, or if they paid no points at all. I considered a 15 year loan and a 30 year loan. And I considered what would happen if the buyer got out after 5 years, 10 years, or stayed in the home until the loan was paid off.
In each case, the cheapest option was a 15 year loan with 20% down and all 4 points paid at closing. The most expensive was a 30 year loan with 5% down and no points. Even though the monthly payments were higher for the 15 year loan and the cash up front was substantially more, in the long run even the cheapest of our examples saw a savings of $20,000 over just 5 years.
Below is a table that spells out the differences between the lowest and highest combinations of loan variables, excluding the APR markup, which we’ll get to next time.
|Home Price||Total Paid:|
15 year fixed,
20% down payment,
4 discount points
30 year fixed,
5% down payment,
0 discount points
|After 5 years:|
(Edgewater 2 bed/2 ba condo)
(Jefferson Park single family home)
(Lincoln Park 3 bed/2 ba condo)
|After 10 Years|
|Full loan term:|
So, you may know how much cash you’ve got to spend on up-front costs. You may know how much you want to pay per month in order to stay within your budget. However, until you go shopping for a loan you cannot know if the $226,500 house that you purchase will cost you $258k or $417k by the time you sell it off. Only your existing credit history and your negotiation/comparison shopping skills can determine what sort of mortgage you get. But if your mortgage arrangement can affect your bottom line so strongly in the long run, it’s definitely worth taking a few weeks at the very beginning to make sure you’re getting the best deal on that borrowed money that you possibly can.