Showing the difference a single point of interest can make, with our fictional friends Adam and Annie

Let’s say Adam and Annie are married and they want to buy their first house together. They have hundreds of thousands of dollars to use toward a down payment, and they have excellent credit. They both work as lawyers and combined, they make $560,000 a year. They have a year’s worth of income ($560,000) saved for a down payment. Their dream house is $2,800,000. Adam and Annie are comfortably approved for a loan of $2,240,000 at 3.2% over 30 years, which will cost $9,687.26 each month. This means that the down payment plus the 360 mortgage payments Adam and Annie will end up paying to own the house will come out to a total of $4,047,413.60.

Adam and Annie’s best friends, Alex and Amber, who are also lawyers, also have great credit, make the same amount, and have saved as much as their friends, want to move in next door to an identical house selling for the same price. There’s only one difference: it’s now 6 months later, and the economy is a little rockier than it was when Adam and Annie bought their house, so the interest rate has increased to 4.2%. Alex and Amber are approved for a 30-year loan, but they will end up paying significantly more than their friends because their monthly payment will be $10953.98: their down payment plus their 360 mortgage payments will come out to $4,503,432.80. This is 11.12% more than what Adam and Annie paid, just from a 1-percentage point increase on the interest.

Another 6 months later, Adam and Annie are delighted to hear that Arthur and Amanda (Adam’s twin brother and sister-in-law) have bought the house on the other side; they’re now flanked by a brother to whom both Adam and Annie are very close, and their best friends whom they’ve known since law school. A year into the recession, and things don’t seem like they’re getting any better. This third couple is very similar to the first two: young, determined lawyers with great credit and lots of money saved up for a down payment. Their loan officers want to get them the best rate they can, but because of the recession, which hasn’t gotten better (in fact, it’s gotten even worse), the best the bank can offer is 5.2% on the $2,240,000 for 30 years, driving up their monthly payment to 12,300.08. Arthur and Amanda, therefore, will pay $4,988,028.8 counting their down payment and 360 mortgage payments. This is 10.76% more than Alex and Amber are paying (at a rate 1 point lower), and, equivalently, 23.24% more than Adam and Annie are paying (at a rate 2 points lower).

This was framed in terms of owing interest to a bank for a mortgage, but a simple change of perspective-- that we are now owed interest on our money-- reveals the same pattern. If there are 3 banks that offer you 3, 4, and 5 percent interest on your savings, the 3% bank will give you some interest, the 4% bank will pay you more, and the increment from 4% to 5% will be bigger than the increment from 3% to 4%. The lower interest rate you can get as a borrower, the better since you pay less interest to the bank; the higher interest you can get from the bank on your savings, the more your savings will grow.