Using the annual percentage rate (APR) to determine the actual cost of the mortgage loan is better than using just the interest rate. This is because APR takes into consideration the discount rate, origination fees, mortgage insurance premiums, and prepaid mortgage interest when calculating the total amount. The Truth in Lending Law requires mortgage companies to disclose the APR on the loans when they advertise their rates. This prevents them from advertising misleadingly low interest rates.
Discount Points – commonly known as “points”, the discount points are increments of one percent of the mortgage you need to pay at closing. If the discount points are not required or if you choose to pay it off to lower your interest rate, it may not be included in the APR. However, if paying discount points is required, it will be considered in the calculation. Origination Fees – this is the fee that a lender will charge for the work they do on the borrower’s behalf. A lot of borrowers confuse the origination fee with discount points, it is important to be aware of their difference. Mortgage Insurance Premiums – basically, this premium is an insurance against defaults on the loan. Most lenders require mortgage insurance if the down payment is less than 20% of the house selling price. Prepaid Mortgage Interest – because interest is usually paid monthly, the prepaid mortgage interest is charged at closing to cover the cost between the time of closing and the first of the next month. Although the mortgage APR is more comprehensive than the interest rates, it still doesn’t tell the whole story. There are many associated fees you need to pay in home buying including title insurance. The APR is not an exact science; it is an estimation of the total cost you need to shoulder annually when you borrow money for your home. Nonetheless, the APR is the perfect place to start when you’re comparing offers from lenders.
Mortgage APR Example
To give you an idea about how APR works in actuality, look at the two scenarios below. Imagine that you are looking for a 30-year mortgage with a value of $100,000
Lender “Y” offers a 30-year fixed mortgage at 6% interest rate
Lender “Z” offers a 30-year fixed mortgage at 5% interest rate
The instinctive reaction is to choose Lender “Z” because of the seemingly lower rate. However, Lender “Z” also charges $2,500 origination fee and three points (or $3,000) on the $100,000 loan. Lender “X” charges no such fee. So while Lender “Z” has a more attractive interest rate, Lender “Y” is potentially the better choice because it will not charge you $5,500 more on the loan.
Many websites including MyBankTracker.com have mortgage APR calculators that will enable you to compare offers and determine the actual amount you need to pay. Remember to compare loans with similar amounts and timeframe (ie. two 30-year fixed mortgage).
Lowering your Mortgage APR
Today’s economic downturn caused a significant decline in home prices. In real estate, today’s situation can be described as a “buyer’s market” because buyers are in a better position to negotiate home prices. Even if you already own a home, you should look into your current mortgage because you can lower your monthly mortgage payment.
There are many ways to lower your mortgage payment but certain methods are consistently mentioned because of there effectiveness. These include eliminating Private Mortgage Insurance (PMI) and refinancing. In the worst case scenario, it might become necessary for you to sell your home.
If your down payment is less than 20%, majority of lenders will obviously ask for the private mortgage insurance which can dramatically add to the monthly. The easiest way to get rid of this expense is to put down more than 20%. But not everyone can afford to pay such steep rates. An alternative would be to try the piggyback mortgage. For example, the first loan should cover 80% of the price while the second loan covers 10%. The remaining 10% should be paid by the buyer.
The 80% and 10% can be borrowed from the same lender; if this is the case, the closing cost can be treated as one. If it comes from two different lenders then there are separate closing costs for each of them.
Refinancing to Lower Interest Rates
Borrowers with credit scores below 600 are usually able to get their mortgage by agreeing to pay the subprime rate. If your credit score has improved over the years, you can qualify for a better rate based on your credit score. Having less unsecured debts, on-time payments, and increased income are some of the reasons why your credit score improves.
Refinancing to a Conventional Plan
A lot of home buyers chose the adjustable rate mortgage (ARM) option to buy their homes. The mortgage rates used to be very affordable. However, it is important to consider that rates can vary significantly over the long term. Loans will inevitably readjust and sometimes, they readjust to a very high amount. Some home owners are unable to pay their monthly payment because of this.
According to Joyce Windschitl of Prime Mortgage, “No one should continue with a subprime ARM because of the high interest rates…unless there is absolutely no other option.” The advertised rates offered by lenders should be ignored because it is subject of market factors, your credit score, loan to value, and other considerations.
Extend the Term of the Loan
This technique should only be used when absolutely necessary. Some home owners decide on this alternative when they get laid-off from work or if they need money during an emergency. Take note that extending the terms of the loan will cost you a lot more over the long term though it will effectively reduce your monthly payment now.
Consider Other Options
If you can no longer afford to pay the mortgage even after you extend the term of the loan, it is important to look into other options such as selling your house and renting an apartment until your credit score improves. Keep in mind that selling your house should be one of your last options because of the tumbling house prices today. You will not get the best price for the property and this is a decision you might come to regret once the housing market recovers.