There is only one type of fixed-rate mortgage that should interest you, the no-no mortgage. The no-no mortgage has no closing costs and no points. You should pay absolutely no fees to acquire a no-no mortgage. The trade-off? The interest rate.
When you talk to a mortgage broker or browse websites for rates, you’re often presented with a list of available rates and their closing costs. The more of a discount on closing, the higher the rate. For a cost-saver, your first logical thought is that it makes sense to put a little extra in up front to save in the long run with the lower rate. This is the right approach for most purchases, but not for a mortgage.
There are two reasons for this. The first is that you’re likely to move well before your 30 year mortgage is up. You may not stay in the house long enough to recoup the extra closing costs. The second, and more important reason, is that by paying extra for the mortgage you’re effectively betting that the market has bottomed out. If you’re brilliant enough to make that kind of prediction, you should be able to pay for your house in cash. If you’re wrong, and the rates do drop in the future and you want to refinance, that extra money you paid for your slightly better rate was wasted. And guess what, many people pay again for lower rates when they refinance! This is foolish, don’t gamble on the market.
Instead, you should consider the no-no plan. The no-no plan is simple. Pay no closing costs and no points (no-no) on your initial mortgage. Then, if rates drop, refinance to another no-no mortgage. You won’t pay anything to refinance to the lower rate. You can refinance every few months if you want, if the rates keep dropping, just to be sure that you lock in to the latest and greatest rate, for free!
In the worst case, the market doesn’t drop below the current rates for many many years, and you never get the opportunity to refinance. In that case, you saved a bit of money on the closing costs and your rate is only slightly higher than it would have been. If, however, the market does drop below the current rate, then you can follow the rates down to the bottom without paying for it.
One last thing to keep in mind is that refinancing resets your loan (say back to 30 years if you get a 30 year mortgage). If you take the full 30 years to pay off the new loan you might spend more in interest than if you keep your existing loan. The simple solution is to refinance, but make sure you pay the same principal each month you would have on your old loan so that you pay off the loan in the same amount of time, but with less interest. I will post a refinancing calculator here soon.
To sum it up, buy your first mortgage with no closing costs and no points. Then, if and when the interests rates drop, refinance to another no-no mortgage. This way you’re never betting on the bottom. You’ll pay an 1/8 to 1/4 of a point for the no-no loan, but if the rates ever drop you can refinance for free. If the rates never drop you’ll have only lost a small amount.