Mortgage Loan Rates, APR and Points: What Some Lenders Won’t Tell You

When you apply for a mortgage, there are a lot of terms and numbers thrown around. Different lenders offer different rates and fee structures, even for FHA or VA loans, and making sense of it all can be a real headache. Here are some definitions to help you sort the chaos:

Rate:
The Interest Rate (Rate) is the percentage of the loan principle (the amount of money borrowed) charged by the lender; interest is the price you pay to borrow money, and the rate is how they calculate how much you will be charged. Mortgage interest in typically calculated annually, so if you borrowed $100,000 for a year at a 4% interest rate, you’d owe the lender $4000 (100,000x 0.04) in interest for that year. However mortgage loan interest is usually charged monthly throughout the life of the loan, so the lender would charge you $333.33 (4000 / 12) each month of that year to pay the interest.

APR:
The Annual Percentage Rate (APR) is the rate plus any fees and additional costs added into the loan; the so-called “real” cost of the loan. APRs are calculated using a standard equation incorporating all of the fees and charges into the rate percentage so that the full cost can be easily compared. This full cost can be seen as the percent of the principal that you actually pay to the lender (how much money they’re making off of you) spread over the full term of the loan (such as 30 years) and then divided out as an annual (yearly) percentage rate. Lenders are required to disclose the APR to borrowers.

Points:
Discount Points on a mortgage are prepaid interest; by paying interest in advance you can lower your mortgage rate .25% per point. Points cost 1% of the principle, so for a 100,000 loan each point is $1000, and borrowers can typically buy as many as three. On that loan, each point will reduce your monthly payment by about $15 a point.  So by paying an up-front fee for discount points, you get a slightly lower payment, but to ‘break even’ on that $3000 investment will take you a little over five years.  Purchasing points is a good idea if you plan to live in the home for a long time (at least a few years past your break even date), but not a good investment if you plan to say in the home short-term.
*Note, on itemized taxes, discount points are tax deductible (Schedule A).

The Tricky Bits:
Some lenders will quote you a rate “without points,” but that doesn’t mean there aren’t any points being used. Lenders use invisible points: points that they apply as a discount program rather than points you actually purchase yourself to achieve the rate, but those points can show up in the APR. Lenders also use “sale prices” like closing credits (basically a reduced closing fee), varying the assortments of fees (such as funding fees, preparation and processing fees, and fees associated with getting appraisals, underwriting, a closing attorney, etc,. some of which can change due to the daily market, others can be negotiated) to manipulate costs, making today’s APR different from yesterday’s, even though the rate appears the same. While some lenders do this to help keep rates stable in a shifting market, there’s room for some shady behind-the-scenes as well. Keeping rates stable works in the opposite direction as well. Lenders use negative points to raise the rate and use the buy-back money to offer closing cost discounts or credits or other ‘waived’ fee offers. However, some brokers use this frequently undisclosed process to award themselves increased commissions out of the negative point funds. Clarifying the rate and points issue, and getting an itemized fee list and negotiating fees, can help you save money and get a clear idea of what you’re buying.

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About David GoldsteinDavid Goldstein is an Owner and Founding Partner of Express Schools, LLC. which operates online education providers Real Estate Express, Insurance License Express and License Tutor. Follow him on Twitter.

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