Total Mortgage Cost and Mortgage Choice
Most home buyers choose a mortgage without fully understanding its
cost, or the cost of other available options. This is crazy!
The Total Mortgage Cost Challenge
The main reason that home buyers ignore total mortgage cost
is they don't know how to compute it. This is understandable since
total mortgage cost is made up of many factors - interest expense,
discount points, down payment,
private mortgage insurance, etc. - and these factors
interact in complex ways. For example,
- Interest expense varies from month to month, based on the
current loan principal.
- The loan principal is affected by the down
payment and by the home buyer's
prepayment
activity.
- Private mortgage insurance is affected by the loan principal,
down payment, and prepayment activity.
- And all of the above factors are affected by the length of
time that the home buyer lives in his home.
In the face of all this complication, computing the total cost of a
particular mortgage option seems like a big challenge. What's a home buyer to do?
The APR: An Imperfect Solution
The annual percentage rate (also known as the APR)
describes the total cost of a mortgage, including closing costs
and lender points, over the full term of a loan. Since lenders
are required by law to show a loan's APR,
home buyers often use the APR to compare mortgages from different
lenders. There are two potential problems with this practice.
- Different lenders may include different fees in their
calculation, invalidating comparisons between lenders.
- The APR is computed over the full term of the loan.
Since home buyers seldom keep the home for the full
term, the APR can be misleading.
The Mortgage Calculator: A Better Way
The best way to compare mortgage options is to compute their total
cost over the period that the home buyer actually owns the home.
Fortunately, it is easy to do this with a good mortgage calculator.
This website provides a free
mortgage calculator
that does all of the heavy lifting for you.
You can use the mortgage calculator to assess total mortgage cost for 10 different
kinds of mortgage. And you can compute total cost for any
loan duration,
whether you keep the loan for the full term or whether you pay it off in only
a few years. To see how, review the
total mortgage cost sample problem.
A Final Thought
Some home buyers do not do any analysis at all. They rely on "gut
feeling" or they blindly follow the recommendation of their loan
officer. That can be a costly mistake.
The best course is to consider
different mortgage options, evaluate each using the mortgage calculator,
and choose the one that best
meets your personal and financial goals.
At a minimum, you should know the likely total cost of a mortgage
before you actually buy it.