Friday, April 27, 2007

How to choose a mortgage offer

When my wife and I decided on a house, we needed to choose a mortgage. It was easy to get offers, but it was very difficult to compare them. Someone has said the house isn't your most expensive purchase -- the mortgage is -- because the mortgage can end up costing more than the house over its lifetime. This is a simple system I decided on to rank mortgages.


  1. Collect all the fees, charges, points, down payment, etc. that have to be paid at closing. If the Lender pays some of the closing costs, add these in, too. (Of course, those should be negative numbers, since the sum we're making here is a cost.)Call the sum of these numbers NRC (for non-recurring charges).
  2. Determine a comparison time duration; for me, that was five years (60 months); this value is months. This number should reasonably be the minimum amount of time you might spend in the house.
  3. Determine the monthly payments for principle, interest, and any other fees required; this is MRC (for monthly recurring charges).
  4. For each mortgage offer, calculate a total cost of cost = NRC + months × MRC.
  5. Choose the mortgage with the best marketing graphics.


Points is a term for interest that's paid at closing. Why on earth would you do that? Because the lenders will give you a discount on the annual mortgage interest rate in exchange for getting some of their cash up front. They've got cash-flow issues too. There's usually a break-even point; if you pay points and keep the mortgage only a few months, you'll come out behind; but if you pay a bit in points up front and keep the mortgage several years, you'll likely end up paying less.

But Mark, you might be saying, The down-payment is a variable, and the points you pay is a variable -- you can choose both of them. They're really bounded only by how much money you have in the bank. So how do you perform the procedure above with these two almost-free-variables? It turns out the down payment and points is not a free-variable at all -- they actually make you pay that money. It can be very expensive. To figure this part, I determined the minimum amount of money I wanted to have leftover for an "emergency fund", and to cover expenses of the move. The remainder of my cash was what I put into the points and down payment. Then for each of the offers, I got a few quotes from the bank. They usually came in the form of "Pay XX% in points, then the interest rate will by YY%, making a monthly payment of $MMM". I think I got four different such combinations from each of the leading lenders, including one that was 0% points.

This system isn't perfect; for example, the marketing graphics may be poor for a good lender. Not only that, it doesn't account for the tax deduction you can get in money paid in points. To do that, you'd actually have to work hard, estimating your tax rate, and subtracting from the amount you pay in points the discount in taxes you'll get for paying those points. I'm fairly sure that'd require algebra, and this was intended to be a simple guide.

Ultimately, it turned out that Bank of America was the cheapest. That was actually shocking; it was impossible for me to see that through all of the different fees and charges. But when I figured out the five-year cost of the mortgage, BoA was the cheapest by several hundred dollars. It was also shocking how close many of the offers were to each other, even though their rates and points and fees all varies so much going in.

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