Rates

The biggest cost when you borrow money for a mortgage is the interest.

If you borrow $100,000 with a fixed 7% interest rate to buy a home, by the time you pay off the loan 30 years later, you will have paid almost $140,000 in interest alone, well more than the cost of the property itself.

So it is important to understand your loan rate and shop around to get the best rate you can. Supporting Content Box A, B

Interest Rate: this is the rate you pay for “renting” the money to purchase or refinance a property. You pay this on top of the amount you borrowed.

So in the example above, you pay $665.30 per month for 30 years. This covers:

$100,000         loan principal (the amount you borrowed)
$139,509         interest (the cost of borrowing)
$239,509         total amount paid over 30 years

Annual Percentage Rate: this is a better measure of the total cost of a loan than the interest rate, which is why the Federal Truth in Lending law requires that all lenders state the APR in their advertisements.
- Total Cost of Borrowing: It is supposed to measure the “true cost” of the loan, and include not just the interest rate, but also the fees associated with the loan (that you normally pay at closing).
- Different Rules Used: But while it is designed to help a borrower compare loans from different lenders, it’s not a perfect number because different lenders use different rules to calculate the APR.
  
  (And most loan officers can’t tell you how their loan APRs are calculated because it’s all done by software these days.)
  
  So the loan from Lender A with a lower APR isn’t necessarily cheaper than the loan from Lender B, since A’s APR might not include the loan application fee and Lender B’s APR does.

Comparing Apples to Apples: To truly compare the cost of one loan to another, you need to:
- Gt a Good Faith Estimate from each lender for the loans you are comparing. This lays out all of the estimated fees of the loan.
- Delete all of the fees that are independent of the loan (homeowners insurance, title and escrow fees, attorney fees, etc.)
- Add up the loan-related fees and compare the two loans
  
  This is more effort than most people are willing to go through (unless you are working with a mortgage broker, who can often generate the estimates quickly). For a ballpark estimate, use the APR to compare mortgages to find the one that’s best for you.
15 vs. 30 Year Loans: please note that you can’t use APRs to compare loans of different terms, since the fees are amortized over different periods of time. A 15 year mortgage could have a lower interest rate, but a higher APR because the fees are spread over a shorter amount of time.

Points: A point is 1% of the total loan amount. So for a $100,000 loan, one point is $1,000.
- Paying Fees: There are a couple of loan fees which are often charged in points:
  - Loan Origination Fees
  - Rate Locks

Interest Rate Adjustments: Points are commonly used to adjust the interest rate for the loan. The relationship is like a seesaw: the more you pay upfront, the less you’ll pay long term, and vice versa:
- Discount Points: You pay discount points to lower the interest rate of the loan, which in turn lowers your monthly payment.
  - So this is money you pay upfront (at closing) to save money over the term of your loan.
  - Each point you pay typically lowers the interest rate by .25%
  - This is often called “buying down the rate,” or getting a “Buy Down Mortgage.”
  - This can be a good idea if you have the cash available at closing and plan to hold onto your mortgage and your property for a long time.
  - In a buyer’s real estate market, sellers will sometimes pay discount points to make their properties more attractive.
  - Points paid to purchase a home can be tax deductible in the year of the purchase
  - Points paid to refinance a home can also be deductible, but most be stretched out of the term of the loan (so you can deduct 1/15^th or 1/30^th of the amount each year).
- Rebate Points: Rebate points are credits you use for paying some of your closing/settlement costs in exchange for a higher interest rate.
  - So this is money you receive at closing to cover some of the costs of the purchase and you will pay it back over the course of the loan (raising your rate and monthly payment).
  - Each point you take typically raises the interest rate by .25%
  - They can only be used to cover “non-recurring” closing/settlement costs (title insurance, appraisal and origination fees, etc.), you can’t get cash back from rebate points.
  - This is a good way to handle some of your closing/settlement costs if you are short of cash at closing, especially if you only plan to have the loan or the property for a short time.
  - Zero-Cost Loans: this is a loan with enough rebate points to pay for all of your non-recurring closing costs. You still have to pay for the recurring costs such as the first 6 months of property taxes, the first 2 months of hazard insurance premiums, and the first 2 months of mortgage insurance (if required).

An example of how points affect a loan ($100,000 at 6%):

Points	Interest Rate	Action	Monthly Payment
1 (Discount Point)	5.75%	You pay $1,000 for the lower rate.	$584
0	6%		$600
-1 (Rebate point)	6.25%	You receive $1,000 for closing/settlement costs and have a higher rate.	$616

Choosing what to do depends on your individual situation, some borrowers want to keep their upfront costs as low as possible and are fine with a higher interest rate, others want the lowest rate possible.

Effective Rate: the effective rate is the most accurate measure of the cost of a loan, and the best way to compare total borrowing costs, but it is difficult to calculate and so isn’t often used.

The effective rate shows the total cost of the mortgage (interest, discount points and fees) spread over the number of years that you expect to hold the mortgage. While most loans have a term of either 15 or 30 years, most people either move or refinance in a much shorter amount of time.

If you refinance your loan at the end of year 5, the APR calculation includes interest you will never pay, and spreads the costs out over too many years (you pay the fees at closing: instead of paying 1/360^th of the fees each month, your calculation should be that you’re paying 1/60^th with each monthly payment).

So if you can estimate how long you will have the mortgage, you can apply the total cost over the period you will actually be paying those costs and see the actual cost of borrowing.

Monthly Payment: when the lender quotes your monthly payment, they are stating the amount of principal and interest you will need to pay each month for the loan.
- Not The Full Amount: This can be confusing, since it doesn’t include taxes, or required homeowners or mortgage insurance. And for many buyers, the check they write to the lender each month will cover all of those amounts because the lender will require the borrower open an impound account.
- Impound Account: Lenders require the impound account to make sure that their investment in your property remains safe from liens placed due to nonpayment of taxes and insured in case of damage.
  
  You pay a percentage of the projected property tax and insurance bills with your monthly mortgage payment. When the bills are due, the lender pays them with funds from the account (you get the interest earned on the money while it was collecting).
- Check Your Statements: Even though the lender pays the property tax and insurance bills, you should check your statement to confirm accurate payments. Lenders make mistakes too, and they should be responsible for any penalties if the payments are not received on time.
  
  It’s also important to stay on top of these payments because if your mortgage is sold, sometimes records don’t get transferred to the company that will service the loan. You will need to make sure the new servicing company has accurate and complete records for your impound account.

Closing the Impound Account: You can usually request to close your impound account and take direct responsibility for paying your insurance and property taxes when:
- Your equity (in an owner-occupied home) reaches 20-23% and
- Your payments are current and
- You have a good record of making your monthly payments on time
Your monthly payment will then be the principal and interest amount the lender quoted to you at the start of your loan.

Rate Locks: interest rates change every day, sometimes more than once a day. Once your mortgage application is approved, you will want to lock in a good rate. (Otherwise, you may get an unpleasant surprise at closing when your interest rate is higher than when you applied.)
- Guarantee: the rate lock is a written agreement guaranteeing a specific rate on a mortgage
- Period: rate locks are usually for 30, 45, 60 or 90 days. You need to complete the property purchase or refinance within the lock period. If you require more time, often you can pay to extend the lock.
- Costs: in general, the longer the lock, the more points you will pay, since the lender is taking more risk for a longer period of time.
- Tradeoff: since paying 1 point generally adjusts the rate by .25%, you should consider whether rates are rising fast enough that it makes financial sense to pay for the rate lock

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