APR and Mortgage Problems

Posted By: Dr. Frugal in Loans on 09/12/2007 at 20:37:38

If the APR number is supposed to help consumers compare mortgage loans, it doesn't do a very good job unless the loans being compared use identical expenses and fees. Even then, the APR can distort the picture.

Which is the better loan: a mortgage with a lower rate but higher fees, or one with higher rates and no fees· People are used to paying down interest rates with fees, but that's not the case with these mortgages. The fee is just a fee. You need to do the math before you jump to the conclusion that the lower interest rate is automatically the best deal, because it may not be. Here's an example:

You are looking at two loans that have different interest rates (and APRs), but one charges a fee while the other doesn't. Bank A has a loan for 6.25% with a $2500 fee and Bank B has a loan for 6.5% with no fee. The APR for Bank ! is 6.375% and Bank B's is 6.68%. Which loan is the best deal·

On the surface, Bank A seems to have the better offer--after all, the fee is a one-time payment. However, the interest rate determines your monthly payment for the life of the loan. As always do the math and see if what seems obvious is, in fact, the better deal.

If you chose Bank A's loan, you will save $27 a month on your mortgage payment but you will have to pay $2500 for that deal. TO break even, it will take you 93 months of saving that $27 to break even--that's seven years and nine months. Considering the life of the average loan is around four years, does that make sense·

Another consideration is that the fee you pay the lender is probably not tax deductible (it's not a prepayment of interest). The extra $27 is partly interest and partly principal. In the first years of a mortgage, most your payment is interest so most of that extra $27 will be tax deductible.

Comments

Posted by Abby at September 15, 2007, 8:57 pm:

That example was a little unclear. Can you give a couple more?


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