There are no shortages of acronyms in the mortgage industry. However, today I’ve borrowed a powerful one from the world of finance theory.
TVM = Time Value of Money
TVM is complex to solve for but relatively straightforward to understand. It behooves us to apply TVM theory in determining whether or not to “buy down” your interest rate.
The Lowest Interest Rate is Not Always the Correct Loan
Isn’t the mortgage with the lowest long-term interest rate always the right choice? Absolutely not. You see, when refinancing it’s typically best practice to build up-front closing costs into the loan amount itself. I’ll use a fictitious example to illustrate:
Assuming a $200,000 loan amount with $5,000 in closing costs, the borrower is faced with 3 typical decisions:
So, which choice is correct for you?
Quite frankly, the answer is “it depends”. I’ll cover the first two options using TVM theory.
Option 1: Pay closing costs up front thus reducing the loan amount, APR and monthly payment. I’d characterize this as the “highly conservative approach”. In other words, borrowers choosing this option should answer “yes” to all three of the following questions:
Option 2: Roll the $5,000 closing cost into the loan. This is the approach I typically recommend. Here’s why:
Let’s determine your “breakeven point” together.
This is a very brief analysis we can conduct in approximately ten minutes. Our goal will be to determine a point in time when your refinance “pays you back” and ultimately yields you a profit. The decision regarding closing costs factors into your breakeven point – so let’s dive in sometime soon.
Thanks for allowing me the opportunity to earn your business. I’m here anytime to help guide you through the process.