A home is probably the most expensive asset you will ever purchase. With so many mortgage options available from a wide variety of lenders, getting the best possible interest rate on your mortgage can ultimately save you thousands of dollars. Knowing how different interest rates affect your monthly payment can prove an invaluable tool when making a decision, whether you are seeking a new mortgage or refinancing an existing one.
TL;DR (Too Long; Didn't Read)
Depending upon the size of your down payment and the amount you have borrowed for your mortgage, a 1% interest rate drop could reduce your monthly payments considerably.
Mortgages and Interest Rates
When you purchase a 15-year fixed-rate mortgage, the interest rate will stay the same for the entire life of the loan. Your monthly payment is based on the interest rate you negotiate with your lender and is structured to pay off your mortgage by the end of the 15-year period. This is typically the shortest fixed-rate period offered by lenders and will allow you to pay off your mortgage faster and pay less interest than with a longer term loan. However, the shorter term means your monthly payment will be higher, so consider whether you can afford it.
Interest Rates and Regular Payments
The amount of interest you pay over the course of your 15-year mortgage term will depend on your interest rate. Suppose you are purchasing a home for $220,000 and making a down payment of $20,000 resulting in a mortgage amount of $200,000. If the interest rate on your mortgage is 4.0 percent, your monthly payment will be $1,479.38. That means over 15 years you will pay a total of $266,288.40 to your lender ($1,479.38 x 12 months x 15 years). Subtracting the original amount of the loan, $200,000, leaves interest of $66,288.40.
1 Percent Interest Rate drop
A 1 percentage point interest rate drop can save you thousands of dollars in interest over that same 15-year period. Continuing the example above, if the interest rate on your mortgage were 3 percent instead of 4 percent, your monthly payment would be $1,381.16, or $98.22 less per month. Your total payments over 15 years would amount to $248,608.80 for a total interest cost of $48,608.80. That is $17,679.60 in interest saved compared to the 4 percent rate.
Understanding Percentage Reductions
Another way to look at your monthly savings is to determine the percentage reduction in your monthly payment. In the example above, a reduction of a percentage point from 4 percent to 3 percent meant a reduction in your monthly payment of $98.22, or nearly 6.6 percent ($98.22 divided by $1,479.38).
Matter of Scale
If the beginning interest rate were higher -- 8 percent, for example -- that same $200,000 mortgage would result in a monthly payment of $1,911.30. You would pay $1,797.66 if the rate were 1 percentage point lower. That means you would save $113.64 per month, a reduction of 5.9 percent.
Exploring Mortgage Calculators
A number of mortgage calculators are available online. You fill in the purchase price of the home, your down payment and your interest rate and the length of the loan and the calculator tells you what the monthly payment would be.
Philippe Lanctot started writing for business trade publications in 1990. He has contributed copy for the "Canadian Insurance Journal" and has been the co-author of text for life insurance company marketing guides. He holds a Bachelor of Science in mathematics from the University of Montreal with a minor in English.