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A loan has three facets:
1. size (how many dollars
you need to borrow)
2. interest (the percentage rate you pay on the loan)
3. term (how long it will take to pay off the loan)
The first one is self-explanatory
(although there are choices you can make with regard to the down
payment, which we'll investigate in a little while).
The other two are more complicated.
Let's look first at the interest rate.
The Calculation of APR (Annual
Percentage Rate)
The annual percentage rate is a
method developed under federal law to disclose to loan
applicants the actual amount of interest that will be paid on a
given loan, over the life of that loan. It makes it easy to
compare one mortgage to another by making it an apples-to-apples
comparison. You should, however, use the APR as just one tool in
evaluating a loan, not as the sole factor in making your
decision.
To understand APR, you must first
understand the concept of points. A point is 1% of the loan
amount. If the loan is for $100,000, one point is $1,000.
There are two types of points:
origination and discount. Origination points are the fees
normally charged by a lender, and sometimes by a mortgage
broker, for originating, or starting up, your loan. Discount
points are charged to lower your interest rate, and this lowers
your payments. In other words, if you pay some more money up
front, the bank will let you pay less over time.
Both types of points should be
considered interest that you pay up front. Therefore, you must
figure points into the cost of your loan repayment. If you take
out a loan for $120,000 at 9% interest for 30 years, and you pay
one origination point and one discount point, you're paying a
total of two points, or $2,400. Your payment will be $965.55 per
month.
To get the proper APR on your loan,
then, you have to add that $2,400 to your starting balance,
since (remember?) it is interest, albeit prepaid interest. This
makes your total loan $122,400. Figure the new payment on that
balance, which works out to $984.00. Now return to the original
loan amount and (ready, mathematicians?) compute the polynomial
backwards to reach the interest rate it would take to equal the
payment on the total loan. It works out to roughly 9.23%.
In paying points to lower your
rate, a good rule of thumb is that it will take you about five
years to make up the additional point(s) paid; then you will
begin saving money over the remaining term of the loan.
By federal law, lenders are
required to send you a TIL (no, that's not something you get
your hand caught in when you're stealing -- it stands for Truth
in Lending) statement within three days of applying for a loan.
The Term
The most common term for a
fixed-rate mortgage is 30 years, with 15 years the next most
common.
A 30-year vs. 15-year mortgage
debate rages, but one thing is sure: You will pay much more
interest over the term of the loan (in most cases double) on a
30-year mortgage. On the flip side, a 30-year mortgage will
offer lower monthly payments. You'll be getting a tax write-off
for the interest portion of your payments, which could be
substantial. On the other hand, in the first 15 years of your
loan, you will be unfoolishly lining someone else's pocket with
interest, while not building up significant principal for
yourself.
Example: Let's say you buy a
$150,000 home. You put down 20%, or $30,000, which leaves you
$120,000 to finance. If you get a 30-year loan at 8.5%, your
payments are $922.70. After five years of payments, your balance
owed is $114,588. If, on the other hand, you obtain a 15-year
mortgage at 8.00% (rates are lower with shorter-term loans),
your payments are $1,146.00 ($224.00 more each month). After
five years in this loan, however, your balance is only $94,000.
That's quite a difference when it comes time to sell.
In sum, a 30-year loan is good for
long-term stability. If you can afford a 15-year mortgage, you
will build principal faster. Another option would be to pay what
would be equal to the 15-year payment on a 30-year loan,
enabling you to pay it off in about 15 years (slightly longer
due to the higher interest rate), while still having the cushion
of the lower payment should money problems arise.
Details...
There's one other loan
categorization that has to do with size. A conforming loan
is less than the Federal National Mortgage Association's
legislated mortgage amount limit, which is currently $322,700
for a single-family home. A jumbo loan, also known as a
nonconforming loan, exceeds that amount. Since such jumbo loans
cannot be funded by the agency, they usually carry a higher
interest rate |
