To compare mortgage loans, borrowers consider interest rates, terms, characteristics and costs, and other factors that might apply to their individual situations.
Compare Interest Rates
An interest rate is a percentage applied to a loan balance to determine how much the borrower will pay each month to borrow that sum of money.
A lower rate results in a lower payment for the same loan amount. For example, the monthly principal and interest payment for a $250,000 loan with a 4.5 percent interest rate is $1,267. The monthly payment for the same loan with a 5.0 percent interest rate is $1,342.
In addition to the stated rate, which is used to calculate your monthly payment, you’ll want to carefully compare the annual percentage rate, or APR. The APR is a better indication of the true cost of borrowing. For example, if both the 4.5 percent loan and the 5.0 percent loan came with identical costs, the 4.5 percent loan is obviously the better deal. But what if the 5.0 percent loan costs nothing, while the 4.5 percent loan costs $15,000? In this case, the APR for the 5.0 percent loan is 5.0 percent. The APR for the 4.5 percent loan? It’s 5.004 percent. APR allows you to compare loans with different rates and pricing.
The interest rate isn’t the whole picture for someone who wants to compare mortgage loans. It’s also important to compare other factors that might make a lower rate less attractive or a higher rate more appealing.
Compare Loan Terms
In addition to the rate, borrowers should compare home mortgage rate lock periods, repayment periods, mortgage insurance costs, prepayment penalties, discount points and other characteristics.
Rate Lock: A rate lock period refers to how much time the borrower has to close the loan and receive that rate after it has been locked. A longer lock period is more valuable than a shorter one because the longer lock allows the borrower more time to complete the loan process. A lock that expires can sometimes be extended (usually for a fee).
Term: The repayment period (or term) is the number of years over which the loan must be repaid. A longer term comes with a lower payment but higher total interest costs over the life of the loan. A shorter term for the same loan involves a higher payment, but a faster payoff means less interest is paid. Most home loans have a 30-year or 15-year term.
Prepayment Penalty: A prepayment penalty is an extra sum a borrower could be charged to pay off a loan early. “Hard” prepayment penalties are assessed if the loan is repaid ahead of time for any reason — for instance, selling the home. “Soft” prepayment penalties are assessed only if the loan is paid early by a refinance. A loan with a prepayment penalty almost always has a lower interest rate than the same loan without a penalty.
Mortgage Insurance: Mortgage insurance, or MI, is a policy borrowers pay for each month to reduce the lender’s risk. If the borrower defaults (doesn’t pay the mortgage), the insurer reimburses the lender. Mortgage insurance is required for most loans exceeding 80 percent of the purchase price (or property value, for a refinance). Without MI, many people would need a much larger down payment to buy a home.
Adjustments: Fixed rate mortgages (FRMs) have rates that do not change during the life of the loan. They make budgeting easier and are considered safer by many experts. If you plan to keep your loan for many years, an FRM may be less expensive. Adjustable rate mortgages (ARMs) come with lower interest rates upfront, but eventually, they adjust up or down, depending on the economy, at predetermined intervals. ARMs can be much cheaper, though, for those who don’t plan to keep their mortgages for many years.
Compare Loan Costs
All mortgage loans involve fees and costs. Examples include loan origination fees, title search and title insurance costs and appraisal fees.
Lenders are required by federal law to disclose most loan costs to the borrower on what’s known as a Good Faith Estimate (GFE). This standardized form shows the estimated loan costs and explains which can change at closing and which can’t.
Borrowers can use the GFE not only to compare mortgage loans and costs, but also to reconcile the estimated costs to the final costs, which are disclosed on another form known as the HUD-1. HUD refers to the U.S. Department of Housing and Urban Development, which designed the closing document.
The bottom line for borrowers is that to compare mortgage loans, they should consider each loan’s interest rate, characteristics and costs.