Interest Rate vs. APR
What is the difference between the interest rate and the A.P.R.?
You’ll see an interest rate and an Annual Percentage Rate (A.P.R.) for each mortgage loan you see advertised. The easy answer to “why” is that federal law requires the lender to tell you both.
The A.P.R. is a tool for comparing different loans, which will include different interest rates but also different points and other terms. The A.P.R. is designed to represent the “true cost of a loan” to the borrower, expressed in the form of a yearly rate. This way, lenders can’t “hide” fees and upfront costs behind low advertised rates.
While it’s designed to make it easier to compare loans, it’s sometimes confusing because the A.P.R. includes some, but not all, of the various fees and insurance premiums that accompany a mortgage. And since the federal law that requires lenders to disclose the A.P.R. does not clearly define what goes into the calculation, A.P.R.s can vary from lender to lender and loan to loan.
The A.P.R. on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But ARMs were invented because the market index changes and makes fixed rate loans cheaper or more expensive to make — that’s why they’re variable rate in the first placed!
So, A.P.R.s are at best inexact. The lesson is that A.P.R. can be a guide, but you need a mortgage professional to help you find the truly best loan for you.
Note when you’re browsing for loan terms that the A.P.R. will not tell you about balloon payments or prepayment penalties, or how long your rate is locked. Also, you’ll see that A.P.R.s on 15-year loans will carry a higher relative rate due to the fact that points are amortized over a shorter period of time.
Fixed vs. Adjustable
With a fixed-rate loan, your payment stays the same for the life of your loan. The longer you pay, the more of your payment goes toward principal. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. For the most part payments for a fixed-rate mortgage will be very stable.
Your first few years of payments on a fixed-rate loan go mostly toward interest. The amount paid toward principal increases up gradually each month.
You might choose a fixed-rate loan to lock in a low interest rate. Borrowers choose fixed-rate loans when interest rates are low and they wish to lock in at the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we can help you lock in a fixed-rate at the best rate currently available. Call STELLAR mortgage corporation at (678) 539-8100 to learn more.
Adjustable Rate Mortgages — ARMs, come in even more varieties. Generally, the interest rates on ARMs are determined by a federal index. Some examples of outside indexes are: the 6-month CD rate, the 1 year rate on Treasure Securities, the Federal Home Loan Bank’s 11th District Cost of Funds Index (COFI), or others.
Most Adjustable Rate Mortgages are capped, so they won’t increase over a certain amount in a given period. Some ARMs can’t increase more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM has a “payment cap” which ensures your payment won’t increase beyond a certain amount over the course of a given year. Most ARMs also cap your interest rate over the duration of the loan.
ARMs most often feature their lowest, most attractive rates at the start of the loan. They provide the lower interest rate from a month to ten years. You’ve probably read about 5/1 or 3/1 ARMs. In these loans, the introductory rate is fixed for three or five years. It then adjusts every year. These types of loans are fixed for 3 or 5 years, then they adjust after the initial period. Loans like this are best for people who anticipate moving in three or five years. These types of adjustable rate programs are best for people who will move before the initial lock expires.
Most borrowers who choose ARMs do so because they want to take advantage of lower introductory rates and don’t plan on staying in the house longer than the initial low-rate period. ARMs are risky if property values decrease and borrowers can’t sell their home or refinance their loan.
Have questions about mortgage loans? Call us at (678) 539-8100. It’s our job to answer these questions and many others, so we’re happy to help!
Lock It In
A rate “lock” or “commitment” is a promise from the lender to hold a specific interest rate and a particular number of points for you for a specified period while your application is processed. This prevents you from working through your whole application process and finding out at the end that your interest rate has gone up.
Rate lock periods can vary in length, anywhere from fifteen to sixty days, with the longer spans generally costing more. A lending institution can agree to lock in an interest rate and points for a longer period, such as sixty days, but in exchange, the rate (and sometimes points) will be higher than that of a rate lock of fewer days.
Other Ways to Save on Interest
In addition to choosing a shorter lock period, there are more ways you can score the best rate. A larger down payment will get you a better interest rate, because you’ll have more equity at the start. You could choose to pay points to lower your interest rate for the term of the loan, meaning you pay more up front. For many people, this makes sense and is a good deal..
STELLAR mortgage corporation can walk you through the pitfalls of getting a mortgage. Call us: (678) 539-8100.
How do you “buy” a better rate?
Do you plan on keeping your loan for a while? Then it may make sense to “buy” a lower interest rate by paying one or more “points.”
Even if you’re unsure of how long you plan to keep your mortgage before you move or refinance, paying points now for a lower rate may make sense. For example, do you have a high-paying job now but you think you might change careers in the next few years? We can help you sort it out. It’s part of our goal to find you the right loan for your means and future.
A point — which equals one percent (1%) of the total loan amount — is an up-front fee that lowers your annual interest rate and total interest due over the life of your loan. So, a one point loan will have a lower interest rate than a no point loan. Basically, when you pay points you trade off paying money later in favor of paying money now. You can pay fractions of points, meaning there are a lot of points packages that can make a loan’s terms more favorable if that’s what’s right for you.
There are a variety of rate and point combinations available. When you look at different loan programs, don’t look just at the rate — compare the whole package. Federal law requires lenders to publish their loans’ Annual Percentage Rate, or A.P.R. The A.P.R. is a tool used to compare different terms, offered rates, and points.