One of the most common questions a new home buyer has for their mortgage broker is “what’s the best rate I can get”? This is probably the least understood part of shopping for a new home. Under the Truth in Lending Act, mortgage brokers are required to advertise the APR of any loan along with, or instead of the interest rate. Why is this important, what’s the difference, and is this really the most important thing to consider?
The truth really lies in how long you plan on being in a home. If you are a First Time Homebuyer, maybe you plan on starting a family in the next few years and anticipate selling your home for a bigger home in about 3 years. Or maybe you’re the type of person who plans on buying a home and living there the rest of your life. These two people should look at their mortgage in very different ways.
Let’s look at a house that costs $100,000.00. For this example, we will look only at what’s called “Origination costs”. Yes, there are many other closing costs out there, but let’s really focus on the origination because this is where you can find out who’s giving you the best deal for your goals. Say your rate is 4.5% and you have no origination costs. This means that on a 30-year loan your principal and interest would be $506.69 per month. Since you had no other costs, your APR is also 4.5%.
Why are the origination costs so important? All lenders will have a variety of interest rates available to you, but each is at a different cost (yes, you are the one deciding and buying your rate!). You find out that for one point of the total loan amount (which is fancy mortgage language for 1 percent), you can buy down your interest rate to 4.25%. Now your monthly payment is only 491.94. That’s about 15.00 per month that you are saving, not bad! But wait, you paid 1 point or 1 percent for those savings which cost you $1,000.00. Was it worth it?
If you are the first time homebuyer we mentioned at the beginning that will be looking to move to a bigger house as their family grows, this probably wasn’t the smartest decision. You paid 1,000.00 to save 15.00 per month. You only plan on being there for 3 years, which is 36 months. So if you take that 15.00 per month savings and multiply it by 36 months, you only saved $540.00 over the course of the loan. You pretty much wasted $460.00 by buying down your rate.
Now let’s look at the person who plans on living in their home forever. Let’s say they also choose to pay the 1 point (1,000.00 in this example) to buy down their rate. They plan on living there for all 360 months of the mortgage, and yes, that’s how many months are in a 30-year mortgage. Since they save 15.00 a month for 360 months by buying down their rate, they save 5,400.00 over the course of the loan. Probably worth the 1,000.00 they had to pay up front when they got the mortgage.
Where does APR come into play? That’s what gets interesting. If everyone planned on staying in a home for the entire length of the mortgage, APR would be king. The lower the APR, the less you would end up paying once the mortgage is paid off. But the reality is that you have to look at your long term goals, make the best guess as to how long you think you will stay in the home before selling it, and then do the math. I know it can be confusing, but that’s why you have CBGC Mortgage. We can sit down with you, really understand your goals, and find the mortgage that works best for you!