mortgage rates

Here’s a hypothetical for you:

Two individuals apply for the same type of loan at the exact same lender at the same time. Both loans are for the same amount, and the houses are very similar model homes right next to one another on the same street.

Before we go further, most would assume that the amount of money that both individuals would have to bring to closing would be virtually identical. Right?

In most cases, that’s actually incorrect…

There’s more to the story. There are a variety of factors, such as APR, that play into what the buyer needs to, or should, bring to closing.

APR, or annual percentage rate, is “your interest rate stated as a yearly rate. An APR for a loan can include fees you may be charged, like origination fees. APR is important because it can give you a good idea of how much you’ll pay to take out a loan. Essentially, it is a more complete or “true” cost of borrowing money.

Sooo..it’s just a fancy way of saying interest rate, right? When it comes to home loans, that’s not true – just watch here:

Back to our hypothetical – how does something like APR affect funds to close?

Adjusted APR is calculated by several factors: loan terms, down payment, and origination fee, just to name a few. The final adjusted APR then affects the total cost of the loan as well as one’s monthly payment.

In our example, the reason that both individuals could have different funds to close is that they have differing APRs. That could arise from using two different lenders, their credit scores could be very different, they may have a different amount that they would like to use as a down payment, etc. One or both may also be seeking to pay down their interest rate – a factor in APR. A common strategy to pay down the interest rate is through what are called discount points. This can happen when a lower credit borrower wants to benefit from a lower interest rate amount that would normally be offered without additional costs to another borrower with a good or great credit score.

By paying discount points, one chooses to bring additional cash to closing to “pay down” the loan’s interest rate and benefit over the long run from it. 1% of the mortgage amount equates to 1 point. If one of the individuals wanted to pay down their interest rate, they would need to bring more money to closing than the other, in this example.

Paying discount points is a particularly good strategy if the initial interest rate was high due to credit score or other factors, or if the individual intends to stay in the home for the majority of the term, as the initial cost of paying discount points in this example would have a breakeven point in about 5 years. If the individual intends to move in less than 5 years, this strategy would not be recommended, as they would never reach the breakeven point to recoup their upfront costs.

Buyers are constantly marketed to with APRs, interest rates, and other numbers. Knowing that not all advertised rates are good “apples to apples” comparisons can help set you apart from agents who lack understanding on financing costs. Helping clients understand how these numbers truly work can go a long way in ensuring buying confidence as well as assisting them with making a truly educated decision. Now that’s being a pro!

Have a buyer that could use some help? Have them play this game that explains the factors that affect APR here!

*Figures shown are estimates based on the market conditions as of the date of publication, and are subject to change without notice. Interest Rate for this example is based on an excellent credit score. Actual rate, annual percentage rate (APR) and other figures may vary. Not all applicants will qualify. Please contact us for an exact quote and for more information on fees and terms.

 

Lewis, Holden. “Mortgage Discount Points: What You Need to Know.” NerdWallet, 30 Oct. 2019, https://www.nerdwallet. com/blog/mortgages/discount-points/.

NerdWallet. “What Is APR and How Does It Affect Your Mortgage?” NerdWallet, 6 Sept. 2019, https://www.nerdwallet. com/blog/mortgages/apr-annual-percentage-rate/.