## Mortgages

Also see: the Mortgage Calculator
with Monthly, Annual and Life-of-Mortgage Amortization

Mortgages provide a way to use property (real or personal) as security for the performance of an obligation, usually the payment of a debt. The term mortgage refers to the legal device used for this purpose, but it is also commonly used to refer to the debt secured by the mortgage, the mortgage loan. In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than other property (such as ships) and in some cases only land may be mortgaged.

Points (a point equals one percent of a mortgage loan amount) are fees that the mortgage lender charges for making the loan. In a sense, points are prepaid interest, or interest that is due when the loan is made.

APR (Annual Percentage Rate)... Some lenders charge lower interest rates but more points than other lenders. The APR therefore provides a useful gauge for comparing the total cost of mortgage loans.

Example: A 30-year mortgage with an interest rate of 8.0% and four points would have an APR of 8.44%, while a mortgage with an interest rate of 8.25% and one point would have an APR of 8.36%.

Example:

 The principal used in calculating the APR is equal to the amount of the loan the borrower actually has to use at any time. Consider two one-year loans of \$1,000, each with an interest rate of 10%, or \$100 in interest. 6 Months 12 Months LOAN #1: \$1,000 LOAN Repay \$1,000 Plus \$100 Interest LOAN #2: \$1,000 LOAN Repay \$500 Plus \$50 Interest Repay \$500 Plus \$50 Interest The second loan has a higher APR, even though the amount of interest paid (\$100) is the same on both loans. The second loan has a higher APR because the second borrower, unlike the first borrower, does not have the use of the entire \$1,000 for the entire year, because the second borrower repaid \$500 of the loan after six months. (Another reason the second loan has a higher APR is that the borrower paid half of the interest after six months and half at the end of the year, rather than all the interest at the end of the year.)

Note: APR is not the same as APY.
"APY" is the effective interest rate from the standpoint of a person receiving interest. If you have \$1,000 in each of two bank accounts, each paying the same interest rate, but the interest is credited more often (let’s say, every month, rather than once a year) on one of the accounts, that account will have a higher APY, because the interest will build up more rapidly than on the other account.

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### More about Annual Percentage Rate (APR) and Mortgages

Remember that the annual percentage rate (APR) is an interest rate that is different from the note rate. It is commonly used to compare loan programs from different lenders. The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. Typically the APR is posted next to the rate.

Example:   30-year fixed   8%   1 point   ( 8.107% APR ).

The APR does NOT affect the monthly payments. The monthly payments are a function of the interest rate and the length of the loan.

The APR can be a confusing number. Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the "true cost of a loan." It creates a level playing field for lenders and prevents lenders from advertising a low rate and hiding fees.

If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan. Right? Wrong!

Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. The best way to compare loans in the author's opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.

The reason why APRs are confusing is because the rules to compute APR are not clearly defined.

The following fees ARE generally included in the APR:

• Points - both discount points and origination points
• Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
• Loan-processing fee
• Underwriting fee
• Document-preparation fee
• Private mortgage-insurance

The following fees are SOMETIMES included in the APR:

• Loan-application fee
• Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)

The following fees are normally NOT included in the APR:

• Title or abstract fee
• Escrow fee
• Attorney fee
• Notary fee
• Document preparation (charged by the closing agent)
• Home-inspection fees
• Recording fee
• Transfer taxes
• Credit report
• Appraisal fee

An APR does not necessarily include information about the length of time the rate is locked in. A lender offering a 10-day rate lock may have a lower APR than a lender who is offering a 60-day rate lock.

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### Calculating How Much Mortgage You Can Afford

To seriously attempt to figure out how much a person can afford to spend on a fixed-rate (vs. adjustable) mortgage requires several steps.

1. Calculate gross monthly income (GMI). This is pretty straight-forward. You simply add up your monthly income from all sources. In this example, we’ll assume a husband and wife who make \$80,000 per year (\$6,667 per month) combined. We’ll also assume that they both plan to continue working for the forseeable future.

2. Determine what percentage of GMI will go toward the monthly debt service. The author uses three different percentages (25%, 33%, and 36%). Of course, the lower the better so we’ll assume 25% for this example. At a GMI of \$6,667 per month, this couple can afford to spend \$1,667 on debt service, which includes other debt besides a mortgage.

3. Determine the MAXIMUM monthly mortgage payment. Using the same numbers found in Step 2, we’ll assume that the only other monthly debt this couple has is a \$400 car payment. Subtracting that from \$1,667 gives them a maximum monthly mortgage payment of \$1,267.

4. Subtract property taxes, homeowner’s insurance, and private mortgage insurance (PMI) from the maximum monthly mortgage payment to determine how much can actually go towards the mortgage. We’ll assume property taxes of \$3,000 per year, homeowner’s insurance of \$1,500 per year, and PMI of \$50 per month for a total of \$425 per month. Subtracting this from the \$1,267 we found in Step 3, gives us a net monthly mortgage payment of \$842.

5. Estimate the size of the mortgage. Using the chart below, estimate how much mortgage you can afford based on the net mortgage payment of \$842 found in Step 4. Assuming an interest rate range of 6% - 7%, and a payment of \$842, this couple can afford a mortgage of somewhere between \$120,000 - \$150,000. A lot depends on the interest rate. The lower the interest rate, the more house you can afford.

 Amount of Monthly Income for Mortgage Payment Mortgage Interest Rate 30-year Fixed Mortgage 13% 10% 8% 7% 6% \$700 \$63,280 \$79,766 \$95,398 \$105,215 \$116,754 \$800 \$72,320 \$91,161 \$109,027 \$120,246 \$133,433 \$900 \$81,360 \$102,556 \$122,655 \$135,277 \$150,112 \$1,000 \$90,400 \$113,951 \$136,283 \$150,308 \$166,792 \$1,200 \$108,480 \$136,741 \$163,540 \$180,369 \$200,150 \$1,500 \$135,599 \$170,926 \$104,425 \$225,461 \$250,187 \$1,800 \$162,719 \$205,111 \$245,310 \$270,554 \$300,225 \$2,000 \$180,799 \$227,902 \$272,567 \$300,615 \$333,583 \$2,500 \$226,000 \$284,877 \$340,709 \$375,569 \$416,979 \$3,000 \$271,199 \$341,852 \$408,850 \$450,923 \$500,375 Mortgage Payment Only. Does NOT include real estate taxes or insurance or PMI.