The Interest Rate on Your Mortgage

The interest on your mortgage will be by far the single largest expense over the life your loan, so it makes sense to learn as much about it as possible.

This page:

  • Makes clear the difference between interest and A.P.R.

  • Describes how your choice of mortgage affects your interest costs

  • Begins to explain how you can save money on interest

In the following pages, we'll look at points and rebates (what are they?) , your down payment, PMI and other costs and options.

If you missed it, the first part of this Mortgage Basics guide explained what a mortgage is, how interest rates are set, and how the differences between various mortgage types affect you.

The interest rate defined.
The interest rate on your mortgage is simply the percentage the lender charges you to borrow money. The difference between interest rate and APR is that the APR includes charges beyond the interest rate.

The interest rate includes the margin, which is the lenders' fee and the index rate, which is the amount the bank itself has to pay for the money it's loaning to you.

So how does the interest rate affect your choice of mortgage?

This is simple enough on a fixed-rate mortgage. It is the percentage rate at which your mortgage is amortized over its life, with no variation. It is made up of an index rate plus a margin. What index the lender uses and the size of the margin added are not really important in FRMs, because your rate won't change even if the index rate soars.

With an FRM, your only concern is the interest rate quoted now: the lower the better for you.

It's not so simple with an adjustable rate mortgage. Here, the interest rate you're quoted only applies to the initial fixed period. This rate often is quite low, particularly if the fixed-rate period is short. If you're planning on reselling your new home soon, (around the time the initial low "teaser" rate expires,) this initial rate may be your primary concern. If not, you'll want to dig a little deeper.

As you dig further into your loan's details, you'll find the index and margin your mortgage will follow for the rest of its life. Often a lender will show a chart or list comparing the initial fixed rate with a projected estimate of the rate after that period.

No one really knows for sure what a rate will do in the future, but it's important to note what the rate is expected to do, and the size of the margin the lender is charging.

Sidebar
After you apply at Eloan, you will be presented with all of the personalized interest rate information that you'll need to evaluate the cost of your loan. Chances are, you will be pleasantly surprised. And if your credit is keeping you from getting good deals elsewhere, Full Spectrum Lending will also give you a nice surprise: their sub prime loan rates are lowest in the country.

Lenders will also provide you with an annual percentage rate, or APR. The APR is intended to express the total cost of the mortgage over its life, including interest, lender fees, and discount points. However, paying too much attention to this can be misleading, because the fees included in this number vary from lender to lender (and sometimes from mortgage to mortgage). It's more important to concentrate on the specific combination of rate and points.

Many people unfamiliar with mortgages assume that the primary thing they'll be paying for is the actual cost of their home, called the principle. In fact, nothing could be further from the truth:

Under almost every mortgage plan, the vast majority of the cost is interest.

Under some 15-year FRMs, the total cost of interest is less than the cost of the house, but in most other cases (like any 30-year mortgage), the interest paid will be much higher than the value of the home.

Why then, are 30-year mortgages so much more popular than 15-year mortgages? The size of the monthly payment is a big factor. Paying off a loan over a time period twice as long means significantly lower monthly payments. Also there are the questions of taxes and investing. Interest on a home mortgage is tax deductible; payments on the principal of the loan are not. And at the beginning of a 30-year mortgage, the payments go almost entirely to paying the interest. Of course, the money saved in tax deductions is no where near the amount saved by decreasing the life of the mortgage, but it can be significant.

Wise investing can be another reason to opt for a 30-year mortgage. When the interest rate on a home mortgage is very low, taking the monthly payment difference between a 15-year and 30-year mortgage and investing it in the stock market could easily result in your rate of return being much higher than the interest rate you pay on your home mortgage. High enough to make a 30-year mortgage cheaper than a 15-year loan.

Next: Points and rebates: what they are, and what they do for you

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