At face value, one percent doesn’t sound like very much. If you come across a “one percent sale” at the grocery store, you might be able to, at most, save a few dollars per week.
But when it comes to making much larger purchases, such as a home that is hundreds of thousands of dollars, one percent really can be a very big deal. Knocking one percent off of a $300,000 home will help you save $3,000—but knocking one percent off of your interest rate will help you save even more.
This is why it is so important to compare multiple mortgage offers before making a final decision. If one mortgage provider is offering you an interest rate of 3.5 percent, while another is offering a rate of 4.5 percent, choosing the first provider can help you save tens of thousands of dollars over time.
How Much Does a One Percent Change Affect the Total Cost of the Mortgage?
The exact amount you will be able to save through a simple one percent change in your mortgage rate will depend on several important factors—namely, the total value of the loan (the size of the mortgage). Additionally, whether you are applying for a 15-year or 30-year mortgage will also make a difference.
But let’s suppose you are applying for a 30-year fixed mortgage for a $360,000 home. If you make a 20 percent down payment, the amount you will need to borrow is $300,000.
If you are able to qualify for a three percent rate, you can expect your monthly payment to be about $1,265 (not including taxes, fees, etc.). Considering you need to make 360 payments over the course of a 30-year mortgage, the total cost of the mortgage will end up being $455,400. In this case, $300,000 will be used to pay for the home’s principal and $155,400 will be used to pay for interest (the cost of borrowing).
Now, suppose interest rates were to increase by one percent (4 percent total). If this were to occur, your monthly payment would increase to about $1,432. After making 360 payments, you will have paid $515,520—that means $300,000 contributed to the home’s principal and $215,520 paid in interest expenses.
In this specific example, the person who was able to secure a 3 percent interest rate ended up spending $60,120 less than the person who was only able to secure a 4 percent interest rate. Though these $60,120 in savings will be distributed over 30 years, that is still a lot of money—and by reducing your mortgage rate by just one percent, you can end up saving about $2,000 per year.
Clearly, a one percent change in your interest rate can have a major impact. This is also why millions of Americans will apply to refinance their home every year, which has been especially true over the past three years, when interest rates have been remarkably low.
Even a small change in your interest rate, say one-quarter of a percent (0.25 percent) can still be very influential. Using the same numbers from the example above, a 0.25 percent change in mortgage rates can affect your monthly payment by about $500 per year (decreasing your monthly payments by just over $40). Similarly, a simple one percent increase can quickly cause a mortgage to become much more expensive—by the time interest rates get up to 5.3 percent, you’ll actually end up spending more on interest than your home’s principal.
How Can I Secure a Lower Interest Rate?
Shopping around for a mortgage is something you will definitely want to take seriously—as you just saw, getting a loan with an interest rate just one percent lower can help you save tens of thousands of dollars over time. This is why we strongly recommend comparing mortgage offers from multiple providers.
Additionally, your interest rate might also be affected by your personal financial situation. People with better credit scores can qualify for significantly better interest rates. Taking a few steps to improve your current credit score—disputing collections, consolidating and paying off debt, and others—will almost always be worth it, even if it means having to wait a little longer before buying a home.
You can also consider applying for a loan where the interest rate will matter less. And choosing a 15-year mortgage instead of a 30-year mortgage will mean you have fewer compounding periods, and the total cost of borrowing will be lower (though your monthly payment will be higher). Furthermore, making a larger down payment will help reduce the amount of principal that is exposed to interest, helping you save even further.
By taking the time to understand the cost of borrowing and explore your options, you can find a mortgage that is ideal for you.
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