When you consider taking out the most affordable home mortgage loan, its possible you may only be looking at interest rate. Though an affordable interest rate is essential for a good loan, you must also understand that there are other fees associated with a mortgage that might make it costlier than the interest rate suggests. For assisting consumers to figure out the true cost of borrowing a home loan, lenders create what is known as the APR or annual percentage rate on the mortgage. We are required by law to advertise this useful figure in addition to the base interest rate of the loan.
The interest rate on your mortgage (Note Rate) is the interest rate that the lender charges you as a cost of using the loan for a particular period of time. If you have good credit, then you can qualify for a better interest rate. The interest rate is not the only cost for a mortgage. There are other mortgage fees and charges that make a loan more expensive. This is where the APR comes into play.
The annual percentage rate is formulated to take into consideration the overall cost of the loan by including not only the base interest rate but also the points, closing costs and other fees. For instance, you might need to pay a particular amount of points for getting your mortgage. One point is equal to 1% of the total loan amount. You typically pay points in addition to origination fee’s for reducing the interest rate on your loan. A reduced interest rate implies the lender would lose in the long term. Hence, he would ask for the points as an upfront fee to compensate for the loss in profit. If you paid one point on a loan amount of $300,000, you would be paying $3,000. With the annual percentage rate, this amount would be summed up with the base interest rate to show the cost of the loan more precisely.
The other major charges included in the APR are the closing costs. These include fees like private mortgage insurance (PMI) and application fees. Any service offered by the lender during loan processing is incorporated into the APR. Closing costs can amount anywhere from $2000 to $6,000 depending on the size and type of loan your choose.
To calculate the APR we take the amount you are financing, lets say that amount is $200,000 for this example. We then subtract from $200,000 all of the APR affecting closing costs, for this example we will say all of those add up to $4,500. You would then use the new base loan amount of $195,500. If your Note rate (the rate you will actually be charged by the lender each month) is 5.5% you would then increase that note rate until the payment at $195,500 matches the payment at the original $200,000. This increase in rate would take into account what the closing costs of the loan are going to cost you in the way of an interest percentage over the life of the loan. In this example the APR would be 5.707% roughly.
Knowing the difference between the APR and the interest rate will help you become a more informed home buyer or consumer who may be looking to refinance. Use the annual percentage rate to compare loans. This will make sure you compare apples to apples, helping you choose the cheapest loan for your needs. Beware of lenders that do not include all of the required fee’s into the APR. You can email me if you would like a copy of a correct TIL document showing the APR and a Good Faith Estimate showing all the fee’s that should be included in the APR.
If any of that was over your head no worries this post will be here for years to come for you to come back to again and again until it makes more sense:)
Stetson Lowe
