Interest Rates vs. APRs Points


Let’s cover interest-rate verses APR’s
and what points are. The interest rate determines what the
lender charges you to borrow money. The APR or annual percentage rate is,
to put it simply, the interest rate plus charges and expenses that make up a true
cost of financing. Including points, origination fee, processing fees, interest,
and mortgage insurance. Points are fees paid up front to the
lender to lower the interest rates and therefore your monthly payment. The APR is a helpful tool for
comparing multiple loan offers with varying costs. Let’s look at a couple. These interest rates are exactly the
same but the APR’s are different. Why? Each loan comes with different fees and
when you factor these in over the life of the loan you get the APR. Sometimes the interest rate will be
higher than the others, but the APR are lower. That means the up-front costs are
actually lower. However, the one with the lower rate actually has a higher APR which
means your ultimately pay more over the course of the loan. The APR does have it’s shortcomings as
a method of comparison. Remember the APR spreads those front-loaded
costs over the life of the loan and there’s a good change you’ll move or refinance your loan well before the
long term ends. If that happens your costs are spread
out over a shorter time period changing your actual APR. Here’s an example, let’s say you
refinance or sell after five years. If you chose long 1 then you’re actual
APR changes to 4.407% because those upfront costs are now spread out across 5 years not 30. Compare that to loan 2 which had the
same rate and a higher APR. On that loan the true APR is 5%
if sold or refinanced after 5 years. But loan 3’s APR is still 3.75 because there were no costs. Overall the highest rate loan over 5 years, actually was more affordable. There’s one more spice to add to the mix. Points. Which as mentioned earlier, are
fees paid upfront to lower your interest rate. The cost of each point is 1% of
your loan amount. For example, on $100,000, one point would be $1,000. The amount the interest rate goes down
by point, varies from lender to lender. You should expect a range from .125% to .25% on a 30-year fixed. In general, points make sense the longer
you plan to stay in your home. Think of it this way if paying $1,000 in
points up front would save you $250 a year in mortgage payments Then it will take four years to break
even. And you’ll save $250 a year every year after that. As you shop for lenders know that the
rate reduction you get per point is completely negotiable. And fees associated with points are
considered a cost so they factor into the APR calculations. So that was a lot. Let’s sum it all up. As you shop for a loan
make sure to consider the interest rate, the APR, which includes the total cost
including fees and points, as well as the time you plan to be in
your home. Now go ahead and test out your new found
wisdom. You can easily compare rates, APR’s,
monthly payments, and lenders’ various fees at lendingtree.com.

7 comments on “Interest Rates vs. APRs Points”

  1. Betsalel Cohen says:

    Nice presentation.
    I didn't understand why the example "Loan 3" with 0 points and 0 fees had total loan cost of $1800. (I assume that total loan cost means total upfront fees paid to lender).

  2. Jafar Zaki says:

    how did you get 4.407% for the first loan if it was over a period of 5 years instead?

  3. Alex McCoy says:

    So helpful!!!

  4. J Ma says:

    why does loan 3 has a cost of 1800? should't it be $0?

  5. Josh Flori says:

    great explanation, thanks

  6. Adol Rezli says:

    Outstanding video thank you so much

  7. Larry E says:

    Conceptually and visually the video is great, but your APR calculations are not correct in a few cases. For people trying to follow along using a financial calculator you'd be better off using the correct numbers. Admittedly, your video doesn't actually show HOW to calculate the APR for the shorter loans, but there are other source that do, and your numbers should be consistent with standard methods.

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