COMPARING LOANS AND RATES

Mortgage packages consist of more than interest rates. They consist of a quoted rate, plus discount points (pre-paid interest assessed by the lender at settlement) and other fees. There are a full range of loan terms that should be compared including adjustable versus fixed-rates, low downpayment versus high downpayment, the presence or absence of prepayment penalties.

When you call around to different mortgage lenders, you might find one lender quoting you an interest rate of 6.0% for a 30 year fixed rate, while another lender quotes you a rate of 5.0%. If you automatically jump at the lower rate of the two, it could end up costing a lot more money.

Remember, an interest rate quote always goes along with points to be paid on the loan. A lender can quote you varying interest rates, and almost always the lower rate has the higher points.

Points are charged by the lender as a way to buydown the rate on the mortgage loan. When comparing rates it is always important to also calculate the points involved.

A point is 1% of the loan amount. So if your loan is $200,000 one point would be $2,000. Let's say the interest rate of 5.0% is for a one point loan or $2,000. Maybe the points for the 6.0% loan are 0.50% or $1,000. You will then be paying $1,000 more in points for the lower rate. If the difference in payment is $189 per month, how long will it take to make up for paying the extra $1,000? If you divide $1,000 (the difference in the cost of the points) by $189 (the monthly savings) you will get 5.29. It will take 5.29 months to break even. After that, you will actually be saving money. If you plan on keeping this house for a long period of time and staying in this mortgage you will be saving a lot of money over the life of the loan. After the first 5.29 months you will save $2,268 per year if you take the lower interest rate.

One way to evaluate rates is by examining the Annual Percentage Rate (APR) . The APR can help you compare different types of mortgages. It indicates the "effective rate of interest" paid per year. The figure includes discount points and other charges and spreads them out over the life of the loan.

By law, the APR must always be disclosed to you within three days after applying for a loan. The APR is the effective interest rate for loans that are repaid over their full term. The APR calculation assumes you will be keeping your loan for its full term. However, most people sell or refinance their loan within 6 to 12 years. If you sell or refinance the loan, the value of paying points is diminished dramatically. Similarly, paying points usually does not make sense since once the fixed period is over, the rate will adjust to the fully indexed rate.

In addition, it is not likely to make financial sense to pay points on a 15 year (or shorter term) loans that are fully amortizing. On short(er) term fully amortizing loans, a significant component of the monthly payment involves paying back borrowed principal. This money will not be lowered by paying points and therefore the savings potential of paying points is diminished.

While the APR provides you with a common point for comparison, look at the whole product before deciding which mortgage to get. Pick the one with the rate, payment schedule and other terms that suit your situation best.

To compare costs when shopping for loans ask lenders to quote a rate based on the same points (a one-point loan is good for comparison). That way you can generally see which lender has the better rate. Don't forget to compare the APR also, to ensure the lender with the better rate/point quote isn't adding on additional fees. Always ask a lender whose loan you are considering to provide you with an estimated breakdown of closing costs. That way you can compare more accurately.