How to Compare Loans Side By Side

February 5, 2016 – 

The first time I shopped for a loan, it was a fairly straightforward process.  I spoke on the phone with representatives at a few big banks and I ended up choosing one that gave a 5.625% interest rate for a 30 year loan.  The main reason it was “straightforward” is because I was ignorant about mortgages, and I had no strategy, and no tools.   I didn’t know any better.   That was in the year 2005. 

Today, I would like to share with you some information which may help you the next time you shop for a loan.

Point #1 – when you pay back a loan, for example, referring to the future time when you will pay off the loan, or sell the home, or refinance, this is when the true cost of that loan is determined.  

It’s good to think about this even before you obtain a loan in the first place.  Measure the cost in the future, and think about when you might sell your home or pay off the mortgage.  If I could go back in time to the year 2005 and take out a mortgage for my home again, I would first do a side by side comparison, as follows:

Input data:     (can use either the Loanreader Purchase calculator or Refinance calculator)

  • Loan amount: $225,000
  • Comparing a 30 year loan with rate 5.625 % and closing costs of $1100 versus a 15 year loan with 5.0 % and closing costs of $1400

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In the graph above, the main point is that I ended up refinancing my home 8 years in the future (2013), so for that reason I set one of the snapshots to Year 8 as shown, above (assume the start year in this graph is 2005 rather than 2016).  So what this is saying is that if I had originally obtained a 15 year loan instead of a 30 year loan, I would have been about $23,000 wealthier by the time the eighth year rolled around.  In other words, now that I see the numbers neatly illustrated in this graph, I wish I had originally obtained a 15 year mortgage.  

Now, someone may say to me that since I was in the 30 year loan the whole time during the 8 years, I was actually saving money with the lower payment (the 30 year loan P & I payment is $484 lower each month) … and I could have invested that money to gain interest. 

It’s true that I could invest that money, but it would have been nearly impossible to gain interest yielding $23,000 over an 8-year period.  I probably would have lost money because there was a huge stock market crash in 2008, you may recall.  But the idea is to have a way of measuring the cost in the future and to envision when you might sell the loan or sell the home/move… because that is when the true cost of your loan will be determined.  Timing is really important when it comes to mortgages.

Point #2:   When you shop around and talk with different loan officers, ask what closing costs you are required to pay.  This is an important question to ask.

Notice, above, how the input data shows the closing costs as $1100 for one the option versus $1400 for the other option.   They are close in value, but the idea is that Loanreader calculators allow you to enter the closing costs for the loans being compared, and the information is included in all total cost calculations.  This is important because the closing costs, along with the interest rate, are the two most important numbers which describe a loan that a bank is offering.   

Let’s consider another example.   Say a bank offers you a 20 year mortgage at 3.75% where you pay some of the closing costs.   But the same bank gives you another option of a 3.5% rate where you pay all of the closing costs.   How do you know which is better?   First, it is necessary to find out the actual dollar figure which represents “some” of the closing costs, as well as “all” the closing costs.   Getting this information is really important.  You might have to ask this question to the loan officer several times over to really ensure you get the information.  For the sake of illustration, let’s say $3,000 pays for “some” of the closing costs, and $5,000 for “all” the closing costs.  Enter this information in the Loanreader calculator as follows:

Input data:   

  • Loan amount: $300,000
  • Comparing a 20 year loan with rate 3.75 % and closing costs of $3,000 versus a 20 year loan with 3.5 % and closing costs of $5,000

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Next, click the Calculate button and see the results, especially the Total Cost Graph.  In this example, the Total Cost Graph looks like this:

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The thing to notice here is that during the first 3 years, Loan #1 scenario is better (the 3.75% where you pay $3,000 in closing costs).  But after approximately 3 years, it switches and Loan #2 becomes better thereafter.  For example, if you pay off the loan or sell/refinance the home at year 12, then Loan #2 will ensure you are $5,409 wealthier.  And the last number, $7,309, represents your savings with Loan #2 if you stay with that loan for the entire 20 years.

Having this ability to measure the future activity of multiple loans, side by side, is really useful, especially if you plan to move or sell the home at a particular time in the future.  And the great thing with mortgages is that the numbers are totally predictable … unlike stock investing.  As long as you have a good way to measure the cost, you can make smarter decisions with loans and save thousands of dollars.

Point #3:   Lastly, account for savings with tax deductions (related to the interest payments).  This makes the numbers more accurate.  Loanreader calculators allow for tax rates to be entered (this information can be entered in the Advanced View input form).

We would like to hear if you have any thoughts regarding this topic.  Feel free to post a comment below.
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