Your interest rate is simply the cost of borrowing the principal amount of your loan. Your APR (annual percentage rate) attempts to combine all the costs of your mortgage (interest rate, lender fees, discount points, closing costs, etc.) and represent this total cost as a percentage.
The APR was developed to compare multiple loan options – specifically to weigh the advantages or disadvantages of paying points or fees to a mortgage company to buy down a rate. Let’s look at the chart below to see three examples of a $500,000, 30 Year Fixed Rate loan, with 0, 2, and 4 points to buy down the interest rate.
| Example | #1 | #2 | #3 |
|---|---|---|---|
| Loan Amount | $500,000 | $500,000 | $500,000 |
| Interest Rate | 5.000% | 4.750% | 4.500% |
| APR Closing Costs | $ 5,000 | $ 5,000 | $ 5,000 |
| Points | 0 | 2 | 4 |
| Total Costs | $ 5,000 | $15,000 | $25,000 |
| P&I | $ 2,684 | $ 2,608 | $ 2,533 |
| APR | 5.089% | 5.016% | 4.943% |
Example #1 has an interest rate of 5%, with 0 points (no cost to buy down the rate). Example #3 has an interest rate of 4.5%, which costs 4 points (or $20,000 – 4% of $500,000). Example #3 has the lowest APR, but is this best?
If you made payments for 30 years, you would save money by spending an additional $20,000 to get a lower rate. However, there are two other considerations. Firstly, will you make payments for 30 years? The average 30 Year Fixed mortgage lasts for well under ten years, at which point the home gets sold, refinanced, or the loan otherwise paid off. Secondly, that extra $20,000 you spend today is worth a lot more than the dollars you save many years down the road given inflation, and other considerations.
This may seem confusing, but the bottom line is that a decision on a mortgage shouldn’t be driven by something that can be boiled down generically to a single number, like APR.
At LendSolid, we believe the standard should be to not pay lender fees, discount points, or origination charges when getting a mortgage. Therefore, our loans generally have $0 in lender costs. You have enough other costs outside of the loan, and the costs of paying for a lower rate generally outweighs the possible benefit. Of course, every scenario is different, and we would be happy to review yours!
To learn more about how we can help you with your particular situation, please email or call us today at (301) 325 2542.