What is the difference between Interest Rate and APR?
It is important to understand the difference between Interest Rates and the Annual Percentage Rate (APR) when you are comparing mortgage loans. We'll provide details below, but we will also be with you every step of the way to make sure you explore all loan options and get the loan that's just right for you.
Interest Rate
The interest rate is your annual cost for the money you borrow expressed as a percentage rate. This rate is used to calculate your monthly payment. It does not reflect any other fees or charges you may have to pay for your mortgage loan.
Annual Percentage Rate (APR)
The annual percentage rate (APR) includes more costs than just the interest rate. It also is expressed as a percentage rate. In addition to the annual cost to borrow money (the interest rate), the APR includes:
• Certain fees and charges you are required to pay to get your loan like origination fees, mortgage insurance and third party charges to close your loan.
• Points
Since the APR includes these other costs, it is usually higher than the interest rate. Many of these costs will vary from lender to lender so it is important to understand the charges by looking closely at your Loan Estimate (LE) which must be provided to you shortly after you apply for a mortgage loan.
What are points and how do they work?
Mortgage points may also be referred to as discount points or just "points". These are fees paid directly to a lender in exchange for receiving a lower interest rate. When you "buy down" your interest rate by paying this fee, your monthly payment will be lower.
A point refers to a percentage point and is calculated by multiplying the amount you borrow times 1%, that's $1,000 for every $100,000 borrowed. Points are considered finance charges and are included in the APR.
As a rule, the longer you plan to own your home, the more points can help you save on interest costs over the life of your loan. Here's an example:
This example shows that your savings can really add up if you keep your loan for the entire 30 year term. However, if you don't expect to keep your loan longer than about 4 years, you really won't save very much. So it's very important to consider how long you plan on having your mortgage loan.
There are some important things to know about points.
• The interest rate reduction you get from buying points can vary greatly from lender to lender and even between loan programs.
• The cost of points may provide an income tax benefit. You should check with a tax professional to see how buying them could impact your taxes.
• If you are trying to decide between putting 20% down and buying points, make sure you consider all the factors involved. If you make a lower down payment and have to purchase private mortgage insurance (PMI), the additional cost of the PMI may cancel the savings you get from a lower interest rate.
Does it make sense for you use points to buy down your rate?
To see if using points to buy down your interest rate makes sense, look at whether you have enough cash available to pay the cost of the points up front along with your down payment, closing costs and reserves. Equally important is considering how long you plan to keep the mortgage loan. Buying down your rate may be a good option if you will have a fixed-rate mortgage loan and plan on staying in your home for some time. Divide the monthly payment savings from buying down the rate into the cost of the points to determine the number of months it takes to recoup the cost.
Buying mortgage points can save you a signficant sum over time. It's important to understand how the process works and what the costs are. We are here to help you with these decisions. Give us a call and one of our lenders can get you the answers you need.
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