Mortgages: Rates, APR, Types, and what it means to your wallet

Most people will need a mortgage to buy a home. This purchase for many is the largest of their lives, and it is made of borrowed money.  Even minor differences in loans can create thousands of dollars differences in the long run. When looking at mortgage lenders, you should compare interest rates and APRs. The interest rate is the price you pay for the borrowed money. The APR (Annual Percentage Rate) is the total cost of borrowing the money with fees like finance charges and mortgage origination fees included. There can be differences in the overall price even when the interest rate is the same with two lenders because of the APR. Also, ask your lender about additional processing fees, communication turnaround times, and how much down payment is required for their loans.

Read our article on down payments here.

Being pre-approved by a lender is helpful for sellers, and your real estate agent, because they see that you are serious about purchasing a home. Pre-approval is based on your credit score, income level, and assets. Mortgage pre-approval is a promise from the lender that you’re qualified to borrow up to a certain amount of money at a specific interest rate, subject to a property appraisal and other requirements. The offer is generally valid for 60-90 days.

Read our article on how your credit score affects your loan options here.

There are two main types of Mortgage loans: Conventional and Government-Backed.

A conventional loan is a mortgage that is not guaranteed or insured by any government agency.

  • Fixed-rate loans use a single interest rate—and monthly payment—for the life of the loan, which is typically 15 or 30 years.
  • Adjustable-rate mortgages offer an interest rate that is typically lower than you’d get with a fixed-rate mortgage but only for a certain period -such as five or ten years, rather than the life of the loan. After that initial period, your interest rates and monthly payments will adjust, typically once a year, roughly matching the current interest rates.

Government-Backed Loans are subsidized by the government, which protects lenders against defaults on payments, thus making it a lot easier for lenders to offer potential borrowers lower interest rates.

  • Federal Housing Administration Loans-With a FHA loan, you can put down as little as 3.5%.
  • Veterans Affairs Loans– If you’ve served in the United States military, a Veterans Affairs or VA loan can be an excellent alternative to a conventional loan. If you qualify for a VA loan, you can get a loan with no down payment and no requirement for mortgage insurance.
  • United States Department of Agriculture Loans– USDA Rural Development loans are designed for people in rural areas. The government finances 100% of the home price for USDA-eligible homes. If you qualify for this type of loan, you get a loan with no down payment and a discounted mortgage interest rate.

Mortgage points are also offered on most loans. Buying mortgage points is essentially paying money up front to the lender to get a better interest rate for the life of the loan. In most cases, one point gets you .25 percent off the mortgage rate and costs the borrower 1 percent of the total mortgage amount. For example, if you buy a house and your mortgage is $300,000, one point would cost you $3,000. That would lower your mortgage rate by .25 percentage points, so a 4.5 % interest rate would be reduced to 4.25%. Borrowers usually can buy as many points as they want up to the lender’s limit, depending on how much they want to reduce their rate.

Deciding whether to pay mortgage points depends mainly on your down payment and how long you plan on staying in the home. Let’s say you took out a mortgage for $200,000 and purchasing one point at $2,000 saves you 0.25 percent in interest, reducing your mortgage rate to 4 percent from 4.25 percent. Instead of paying $983 a month, you’re now paying $954, saving you $29 a month. That means it’ll take nearly 69 months to break even, or 5.7 years. But if you were planning to stay in the home long term, over the life of the 30-year loan, you would save $10,502 in interest.

Whether you are getting a conventional loan or a government-backed, ensuring that you recognize how your interest rate and APR affect your finances is vital. Need help determining if your finances are ready for buying a home? Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here.

Advisory services offered through Capital Asset Advisory Services, LLC, a Registered Investment Advisor. This material has been prepared for informational purposes.