Dear Dr. Don,
I am a bit confused about comparing offers from lenders. I see that the lowest rates also have the highest fees, but still have the lowest payment per month. The lower fees have the higher rate and higher monthly payment. Why should I consider the later? Isn't it all about the lowest monthly payment if it's a 30-year fixed rate jumbo loan? Am I missing something here?
-- Tom Twists
Dear Tom,
It's all about the total financing cost. Any part of your loan payments or closing costs, that isn't going toward principal, taxes or insurance, is a financing cost. The Truth in Lending Act, or TILA, requires lenders to provide borrowers with the annual percentage rate, or APR, on their loans. This calculation estimates your total cost of borrowing. It's not a perfect measure, because the lenders have some leeway in how they estimate the fees that go into that calculation, permissible rounding, etc.
The mortgage lending industry can be roughly divided into mortgage originators, mortgage servicers and mortgage investors. The originating mortgage lender gets paid for arranging the mortgage loan. The mortgage servicer gets paid for managing the loan payments. The mortgage investor gets paid for lending the money for the mortgage.
The key to your confusion about fees, interest rates and payments is that the originating lender can get paid upfront with origination points, or the origination expense can be rolled into the interest rate, or the borrower can capitalize these fees by rolling them into the loan amount. One way or another, the originating lender gets paid for the role that it plays in getting your loan to closing. There's really no such thing as a no-closing-cost mortgage.
To add to the mix, discount points are prepaid interest paid at closing. A point is 1 percent of the loan amount. Paying 1 point on a $200,000 mortgage is $2,000. Paying discount points allows the borrower to reduce the interest rate used to calculate the monthly mortgage payment, but paying a point doesn't reduce that interest rate by a full percent. As a rule of thumb, the interest rate on a mortgage is reduced by about a quarter of a percentage point for every discount point you pay. Paying discount points can make sense if you plan to stay in the house and the loan long enough to get past the break-even mark. The Bankrate feature, " Paying mortgage discount points: a primer," explains discount points in greater depth. Bankrate's Mortgage Payment calculator can show you the total interest expense on a loan.
To come full circle here, the APR considers closing costs, points and the interest rate on the mortgage to arrive at a rate that you can use to compare mortgages across lenders. Bankrate always reports the APR on a mortgage. You can calculate your actual APR by using the free trial of a Wheatworks APR calculator.
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