Should I take a higher interest rate for no closing costs?

Question:

I’m looking to get a 30-year fixed mortgage on a $405,000 loan amount, and my lender has given me two options, 3.5% interest rate with $2,700 in closing costs, or a 3.75% interest rate with zero dollars in closing. The lender is suggesting take the zero closing cost option, but I’m not sure why he’s pushing me so strongly towards that.

Answer:

It sounds like your lender might be evaluating the break-even point. So at the 3.5% interest rate, your payment would be approximately $1,818/month, and if you took the 3.75% interest rate (with no closing costs), it’d be $57 more per month. So take that $2,700 in closing costs, and divide it by the $57 to see how many months it’d take you to break-even. That makes your break-even point approximately 47 months (almost 4 years). If you think you’re going to have this home and/or loan for longer than 4-5 years*, it makes sense to go the lower rate.

*Keep in mind the break-even point calculation doesn’t factor in things like inflation…hence adding some extra padding to the 47 months to arrive at 4-5 years. 

Generally people will either sell or refinance the loan in about 3 years, so based on this historical average, I’d suggest locking in the savings and go with the no closing costs option. Of course, you know your situation best, so if this is your “forever home” then get that lower rate!

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