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Articles, tips and techniques for money management and your loans

Jonathan Carter

Does the mortgage world seem like a
long and winding road?

Grasping fundamentals will help map your way.

Entering the mortgage industry world, whether for your first or fifth home, a vacation home or to refinance your current mortgage, is daunting. Understanding some basic concepts will help you determine the product that will be most beneficial to you.

Interest rate clarification

It's important to understand the difference between a loan's interest rate and its annual percentage rate or APR. They're totally different.

The interest rate (also known as the nominal rate) is simply the percentage rate that the lender applies to your loan balance.
The APR is made up of that interest rate, plus the result of other charges and fees.
(The APR is never lower than the quoted rate.) "Points" are one of those "other" charges.
Points, which let you buy a better interest rate, are also a form of interest. But you pay for points up front, so they are sometimes called "prepaid interest". Each point equals 1 percent of the mortgage's value.
A 30-year, $100,000 mortgage with an interest rate of 5.75 percent and two points would cost you $2,000, to be paid at closing.
To calculate the APR, lenders add the loan's interest rate with the points. But the points aren't charged to a single year, instead their cost is averaged out over the term of the loan.
The 30-year, $100,000 loan at 5.75 percent with two points would reflect an APR by paying 5.75 percent annually on the loan balance plus $2,000 up front in points. The result is an APR of about 6 percent or so.
The APR can include other loan-related fees such as mortgage insurance. However it doesn't include fees for title insurance, loan application, the appraisal or document preparation. Your mortgage broker or lender will tell you what additional APR fees to expect.

APR = the common denominator

The APR lets you compare apples with apples.
If you have a choice between a 30-year loan with a 5.75 percent interest rate, two points and $3,000 in fees compared to a loan with a 5.9 percent rate, no points and $2,000 in fees, most of us wouldn't have a clue as to the better deal. By knowing the APR on both loans we now know that the one with the lower APR will cost less over the term of the loan.

But lower doesn't always mean better.
Much rides on whether or not you stay in your home for the entire term of the loan or if you refinance before the term is up.

A loan with high points and fees that is paid off early means the money you pay up front in points and fees will be averaged over a much shorter time period than that used in calculating the APR. So you will have paid a much higher APR than the one quoted when you obtained the loan.

Wait! There's more!

In addition to comparing APRs think about how long you'll be keeping the loan. If there's a good chance you'll sell or refinance, a loan with a higher APR but lower fees may be the better choice.

But if you plan on spending the rest of your life in your home, the loan with the lowest APR is probably the best choice.

Or, if you don't have the cash to pay the up front fees then paying lower fees will be preferable to a lower APR.

Your mortgage broker will help

If you plan on staying in your home for a shorter amount of time than the term of the loan, your broker will help you compare the differences between loans based on shorter terms. Click on HomeLoan Source's "Calculator", at our website, and it will determine the before- and after- tax cost of your loan in annual percentage terms. Just punch in your loan's rate, term, fees and the length of time you'll be keeping the loan.