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Choosing the right mortgage lending rate

When you’re looking to buy a house, you need to find what fits you best. The same is true for mortgages. Sal Khan of Khan Academy shows how the Annual Percentage Rate (APR) may help you determine which mortgage makes the most economic sense for you.

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Let's say you're in the market for a $200,000 30-year fixed loan, and you go to three different lenders. Lender A says, "Look, if you put up $2,000 in fees, then I will give you a 30-year fixed mortgage at a 6.0% rate." You say, "Okay, that's interesting."

Then you go to Lender B who says, "Look, if you put up $5,000. . ." And this would be mortgage fees. It could include things like origination points, discount points. But essentially, if you put up $5,000, then Lender B says, "I can give you a 5.5% interest rate." You say, "Well, this is interesting. I'm getting a lower rate but I have to also put up more money up front." So it's getting a little bit confusing.

So then you get to Lender C, and they confuse you even more. They say, "Look, if you put up $8,000 in all the different types of fees and points and whatever else, I can give you this low interest rate of 5.4%." And so you're a little bit confused. Which one actually makes the most economic sense? And because this is confusing, and no one expects anyone to break out a crazy spread sheet to analyse this in super depth and understand all the underlying mathematics, all the lenders are also required to disclose something called the APR.

APR stands for Annual Percentage Rate. And the whole goal of an APR is to at least attempt to make an apples-to-apples comparison. Now, there's two caveats that you have to keep in mind when you're thinking about this apples-to-apples comparison. One is that this assumes that you have the money. That you're like, "Well, if I had to pay $8,000, if this is the better deal, I've got the $8,000 so I'll do it.” And that's obviously not always true. Some people might not even have the $8,000 up front to go at Loan C, 45 or the $5,000 to go at Loan B.

The other thing the APR assumes is that you're going to hold this mortgage for the duration of the mortgage, that you're going to keep it for 30 years, and we know that's not always the case. You're maybe reasonably likely to refinance your loan before then, or you're likely to maybe even sell your house before then.

So the APR is essentially the effective cost, the effective interest rate of the loan, taking into account the upfront, assuming you keep the loan, in this case, for the 30 years, that you actually pay down the loan. But if you make those assumptions, it's actually quite a useful tool because we see here, if we look at the APR, the Annual Percentage Rate, A has the highest APR, and B has the lowest. So once again, if you're willing to make those assumptions that you're going to keep that loan for 30 years, you're going to pay it off, then it makes the most economic sense to go with Loan B.

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The material provided on this website is for informational use only and is not intended for financial or investment advice. Bank of America and/or its partners assume no liability for any loss or damage resulting from one's reliance on the material provided. Please also note that such material is not updated regularly and that some of the information may not therefore be current. Consult with your own financial professional when making decisions regarding your financial or investment management.

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