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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.