The Basics 5 tips to make cheap mortgages pay

With rates at their lowest levels in 36 years, the challenge is not just finding the best rate but finding the best terms. Here's what you need to do.
By Charley Blaine

Even as mortgage rates drop to their lowest level in 36 years, it still pays to shop carefully.

National surveys put the average fixed, 30-year rate at 6.22% last week, but many lenders are offering lower rates than that, with nominal rates dropping below 6%. (To get more information on mortgage rates, click here.)

But the nominal rate isn't the end of the rate question.

The total cost of the loan -- the annual percentage rate (APR) -- will be higher depending on how much you pay in origination fees and other costs to get the loan. Calculating an APR is tricky, but the rough rule of thumb is that costs equal to 1% of the loan amount add 0.25% to the stated loan rate. So, if your stated rate is, say, 6.45% and your lender charges you a 1% origination fee, your APR would be about 6.7%.

A $150,000 30-year fixed-rate loan with a nominal rate of 8.5% in May 2000 (and an APR closer to 8.8%) may now cost you as little as 6.2% with the APR at just under 6.5%. This knocks the principal and interest payment down from $1,153 to $919, a drop of $235 a month.

Rates for 15-year fixed-rate loans, a popular option for refinancing, fell last week to 5.62%, according to a Bankrate.com survey of lenders. Rates for 1-year adjustable-rate mortgages slipped to 4.57%.

A year ago, 30-year fixed-rate mortgages were at 6.92%, according to lender Freddie Mac. The last time rates were as low as they today was in 1966.

Make sure refinancing is right for you
Homeowners flooded lenders in 2001 with applications to refinance mortgages at the lower rates; refinancings accounted for up to 75% of all loan business. Total loan volume hit a record in 2001, the Mortgage Bankers Association of America says. The association, which predicted in March home loans would fall 25 percent this year, now expects the current surge will boost mortgages to about last year's record of nearly $2.3 trillion..

The question now is how to get the best deal. Here are some tips.

Do some serious shopping and pay attention to costs and the APR. The best mortgage deal balances the rate against the costs. So this is where you want to pay attention to the APR. The lender would prefer, actually, that you keep paying at the higher rate, but it will cost more to replace your business. So, the lender may be prepared to offer less of a rate cut in exchange for lower costs. It's one thing to get a 6.1% loan. But the lender may charge an origination fee equal to 2% of the loan and related costs (title search, recording fees and the like), boosting your APR to 6.6%. If you're borrowing $150,000, that's $3,000 in additional costs, paid now. At 6.4%, it might not cost you anything except the filing fees. When you do your shopping, find terms that are acceptable to you and see if the lender will match them.

Make sure you know how long the lender will guarantee the rate. Lenders will typically lock in loan rates for 30 days, sometimes 60 days. (Some who are swamped with applications may go further than that.) What you want, as our colleague Sharon Epperson at CNBC-TV notes, is a "float down" option. That means that if you commit to take a loan at 6.4% and rates fall to 6%, you can get the lower rate. Some lenders will throw that in as an incentive to do business with them. Some won't. Ask now and remember mortgage lenders are required to give you a truth-in-lending statement three days after you apply for the loan. The statement sets out the amount, nominal rate, APR, term, fees and projected closing costs.

Play hardball if rates fall after you've locked in. Yes, it's stressful, but if rates drop a lot from when you started the process, call the lender. Make him deal -- even if you've put up money to start the mortgage process. The thousands you will save over the life of the loan will easily offset giving up a few hundred dollars.

Calculate how long it will take to earn back the costs of refinancing, if any. On the $150,000 loan, let's say your rate is dropping two percentage points or so and saving you $230 a month. But the costs are 2% of the loan amount. It will take just under 13 months to recover the costs of the new loan from the lower monthly payment. If your loan rate is dropping just a percentage point, it may take closer to three years to recover the costs. If that's the calculation you get, ask yourself if it's worth the cost. A lot of consumer finance experts say it may not be. It depends on how long you plan to live in the house. If you plan to live in the house for, say, 35 years, maybe it's a good deal. If you expect to move within two years, it's probably not. (For the record, families tend to move about once every seven years -- more often when they're young and less often as they age.)

Don't forget the taxes. Many mortgage borrowers forget that if they cut their interest costs by $2,000 a year, the interest saved becomes taxable income. So, make sure you're planning for the effect of the refinancing on your tax bill.