When you refinance a home there are many different factors that can and do affect the final outcome. The refinance interest rate is one of these factors, but it isn’t the only one and it isn’t necessarily more important than the others. You also have the APR. These two factors work together to determine whether or not the refinance is going to be worth your time and save you money, or whether you will end up going through the process and locking yourself into a loan that doesn’t serve you. The goal with a refinance is to experience a financial benefit, and to adjust your loan so you pay out less on your mortgage payment or over time. It’s up to you as a homeowner to make sure this is the result you get.
Refinance Interest Rates
When you are given a quote for a loan you are given two numbers. The first is the interest rate. This is the percent that you will be charged for your loan. For example, if you have a loan of $150,000 and an interest rate of 3.5%, the interest calculates at $5,250 for the first year. This number is then divided by twelve to give you the amount per month in interest. The total is then $437.5. If you pay nothing down on the principle you will pay $437.5 every month in interest payments. If you pay down the interest by a little bit each month, then this number decreases. The original calculation is the base number that is adjusted with each payment to principle. When you get a new loan you are given an amortization schedule. This schedule shows how much of your monthly payment is going to interest and how much is going to principle. You’ll find that over time you’ll be paying more on the principle than the interest, but for the first few years of the loan, you’ll be paying higher interest payment.
APR’s and Refinance Fees
Annual percentage rates are calculated differently. To get the APR the lending institution takes the fees associated with the refinance and adds them to the mortgage amount. So on our example of $150,000 if your refinance costs $2,500, this $2,500 is added to the mortgage amount, bringing your amount to $152,500. Using his calculations the lender will take the new mortgage amount and the current interest rate and come up with a mortgage payment. This is then calculated again to determine the annual percentage rate. Typically the APR is higher than the interest rate.
Now, the refinance interest rate and APR’s working together can be confusing, but basically the APR takes the refinance expense and spreads it out over the life of the mortgage. It then calculates the monthly payment through this. Typically speaking the lower your refinance interest rate is, the better, but that’s not necessarily the case for an APR. If you intend to refinance into a new loan and then stay in the home until that loan is paid off, a low APR will work to your benefit. If you leave the home within a few years of the refinance, your APR makes a dramatic jump and can become quite expensive. Again, this is because the cost of the refinance is spread out over the life of the loan. When you leave, the life of the loan APR changes to the time between your approval on the refinance and the selling of the home.
To save money on a refinance it’s a good idea to know what your end goal is, because then you can make the right decisions regarding your APR. When you refinance a home you are given a few options. On some loans you pay all of the expenses up front and on others you can opt to have them included in the mortgage and paid down over time. And you always have the option to pay points when you refinance. A point is a certain amount paid immediately on interest to reduce the amount paid over time. So if you’re looking at a long term loan, it can be a good idea to pay the costs up front and additional money on points. As a general rule of thumb, the more you pay up front, the less you’ll pay over time. However, because of the way interest rates and APR’s interact, it’s not a guarantee. Calculating the relationship between the two on any loan offer is going to be your best move. While you’re doing this, calculate the time you intend to be in the home so you can get your true cost and savings over time.
Because of the unique relationship between the APR and the interest rate, you will want to work very closely with your lender and loan officer to make sure you know exactly what the percentage will be, what expenses are included in the APR, and what the cost will be over time. This is an area of the refinance that you want to do your homework on because if you don’t, you can end up paying far more than you ever intended.