When you look at online or printed mortgage rate advertisements, you see a lot of plain-vanilla 30-year fixed-rate mortgage quotes. When Freddie Mac creates its weekly press release about mortgage rates, it highlights the 30-year fixed rate. However, if you want the lowest mortgage rates, you can do better by thinking outside the plain-vanilla 30-year fixed-rate box.
How loan features affect mortgage rates
The 30-year mortgage is more expensive than other products because the lender bears what is called interest rate risk, which is the threat of interest rate spikes after the mortgage has been made. This burdens the bank with a money-losing loan. (Interest-rate risk was the main cause of the savings and loan crisis.) The longer the mortgage term, the higherthis risk -- and 30 years is a very long time.When rates are very low, with nowhere to go but up, this risk is intensified. If you have a 3.5 percent 30-year loan, and rates climb to six percent, you won’t be refinancing, and you’ll have less incentive to buy a new home and finance it at the higher rate – that means your lender could be stuck with you and your loan for a very long (and unprofitable) period.Statistics bear this out -- in the low-rate environment that has characterized the years between 2008 and 2012, the average time homeowners keep their homes has increased from six years to nine years!
How much higher are 30-year fixed mortgage rates?
Freddie Mac’s survey for October 4, 2012.Tells the story. Here are the average rates for four programs:
- 30-year fixed -- 3.36%
- 15-year fixed -- 2.69%
- 5-year hybrid -- 2.72%
- 1-year ARM -- 2.57%
All the loans with shorter terms are cheaper than the 30-year fixed mortgage. The 5-year hybrid is a combination of a fixed-rate and adjustable-rate mortgage, fixed for the first five years and adjustable for the remaining 25. Hybrids also come with fixed terms of three, seven and ten years. If you sell or refinance before that fixed period is up, you never have to worry about your loan adjusting, and you pay a much lower mortgage rate.
Other features can increase or decrease your mortgage rate
The loan’s term isn’t the only thing can change your mortgage rate. Optional features can also alter it for better or worse. Here’s a list of features that increase mortgage rates:
- Interest-only payments
- Cash-out refinancing
- 40-year (or longer) terms
- Extra-large (jumbo or super-jumbo) loan amounts
- Balloon mortgages
- Loans with subordinate financing (second mortgages, for example)
And here’s a list of features that decrease mortgage rates:
- Impounds – for loans not requiring the lender to collect property tax and insurance premiums for you (generally loans that are 80 percent or lower), allowing it to do so anyway often gets you a price break.
- Energy improvement – this means borrowing additional money to increase the home’s energy efficiency – Fannie Mae gives you back $250.
- Automatic payments – some lenders give you a break if you set it up so that your mortgage payment is paid automatically from your bank account each month.
This list of factors that can increase or decrease your mortgage rate is yet another reason for getting multiple quotes from competing lenders when you shop for a mortgage. Lenders don’t all march in lockstep when it comes to pricing, discounts or surcharges, so the more quotes you get, the better your chance of scoring a low mortgage rate when you buy a home or refinance your mortgage.