Mortgage Rate Basics
Mortgage interest rates are advertised constantly in the media. But do you know how these mortgage rates were established or how they work? Be sure that you're getting the best mortgage interest rates by educating yourself.

Understanding how to calculate mortgage rates
Calculating mortgage interest rates can be confusing. With variations in compounding, terms, and other factors, it's difficult to compare apples to apples when comparing mortgage rates. For example, what if you want to compare a fixed 30-year mortgage with a mortgage interest rate of 7 percent with one point to fixed 15-year mortgage with a mortgage interest rate of 6 percent with one-and-a-half points. First, you have to remember to consider the fees and other costs associated with each loan to determine the true mortgage rate. How can you accurately compare the two and figure out which mortgage rate is the better deal? Luckily, there is a way to do that. Lenders are required by the Federal Truth in Lending Act to disclose the effective percentage rate as well as the total finance charge in dollars.

Mortgage rates and APR
The annual percentage rate (APR) allows you to make true comparisons of the actual costs mortgage rates. The APR is the average annual finance chare (which includes fees and other loan costs) divided by the amount borrowed. It is expressed as an annual percentage rate, hence, its name. The APR will be slightly higher than the mortgage interests rates a lender is charging because it includes all (or most) of the other fees that the loan carries with it, such as the origination fee, points, PMI premiums, etc.

How the APR works
Here is one example of how the APR works:
Suppose you are shopping for a mortgage and see an advertisement for a lender that is offering a 30-year fixed-rate mortgage with a mortgage interest rate of 7 percent with one point. You also see an advertisement for another lender that is offering a 30-year fixed-rate mortgage with a mortgage interest rate of 7 percent with no points. That would appear to be an easy comparison, right? Actually, it isn't. You need to investigate further. You can do that by looking at the APR.

Let's look at how the APR is calculated:
Say you're financing $100,000. With either lender, that means that your monthly payment is $665.30. If the point is 1 percent of $100,000 ($1,000), the application fee is $25, the processing fee is $250, and the other closing fees total $750, then the total of those fees ($2,025) is deducted from the actual loan amount of $100,000 ($100,000 - $2,025 = $97,975). This means that $97,975 is the new loan amount used to figure the true cost of the loan. To find the APR, you determine the interest rate that would equate to a monthly payment of $665.30 for a loan of $97,975. In this case, that is 7.2 percent.

If Lender 2 charges an application fee of $45, an origination fee of 3 percent (because it's cash you pay at closing, it's the same as points if it's expressed as a percentage of the total loan, but it's not always advertised that way), and other fees that total $775 at closing, then the total of those fees ($3,820) is deducted from the actual loan amount of $100,000 ($100,000 - $3,820 = $96,180). To find the APR, you determine the mortgage interest rate that would equate to $664.30 for a loan amount of $96,180, which in this case is 7.39 percent.

Can you see how your initial thought about good mortgage rates could be wrong? Although Lender 2 advertised no points, because it charged an origination fee it didn't really offer the best deal. Ask for the APR and compare with other lenders. Also, make sure you know which fees are being included in the APR calculation. Typically, these include: origination fees, points, buydown fees, prepaid mortgage interest, mortgage insurance premiums, application fees, underwriting, etc. -- any fees that are coming directly from the lender, but not fees that you would have to pay using any lender, such as title insurance, appraisals, etc.

More things to consider when shopping mortgage rates
Here are some other things to take into account when you look at the APR.

The more you are financing, the less impact all of those fees will have on the APR, simply because the APR is calculated based on the total loan amount.
The length of time you are actually in the home before you sell or refinance has a direct influence on the effective mortgage interest rate you ultimately get. For example, if you move or refinance after three years instead of 30, after having paid two points at the loan closing, your effective mortgage interest rate for the loan is much higher than if you stay for the full loan term.

Determining the best mortgage rate and the mortgage interest rates doesn't have to be difficult if you are armed with the proper information. Use this article as a guide during the negotiation process and secure the a competitive mortgage rate.

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Arnold Cohen
The Mortgage Store
303-488-5435

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