Financial Resource Center: Visit our financial resource center for information to help support you through the unexpected

Why are Interest Rates So Important?

by | May 7, 2018

Interest rates are incredibly important to a mortgage. They dictate how much extra money one pays in addition to their loan amount. Interest is usually added when borrowing money to make a large purchase, or borrowing money in general.

Important Things to Know about Interest Rates

How does one calculate interest? Is it calculated by taking the interest rate and multiplying it by the entire loan amount? It makes sense since houses aren’t cheap and the interest would cost you thousands of dollars.  Many first time buyers don’t understand that the interest rate on your mortgage is actually a monthly interest rate.

In order to calculate how much the interest rate affects your mortgage, take the interest rate and divide it by 12. This is for the 12 months in a year. Now let’s say that you took out a loan for $100,000 and the interest rate is 3%. When you do the math, 3% of $100,000 is only three thousand dollars. Unfortunately, you would not only be paying three thousand dollars in interest.

If you were to turn that 3% into a monthly rate, you would divide it by 12 (3%/12), which comes out to .0025. Now, take that number and multiply it by the principal. The resulting number is how much interest you would pay for that month. In this particular example, the interest due for the first month is already $250. This calculation only works for fixed interest rate loans since they are amortized. Depending on the term you’ve chosen,this means that interest will cost well over the $3,000 you initially thought you were paying.

Why are There Two Interest Rates?

When looking at different rates that the lenders have to offer, you will always see two sets of interest rates side by side. One will be labeled as the “interest rate” and the other will be labeled as the “APR.” Sometimes, both rates will be identical to each other and other times, there is a slight difference. The term “APR” stands for Annual Percentage Rate and gives the mortgagee a clearer idea of what the loan will actually cost them in the first year.

The APR does not have any effect on your monthly payment. If you see two different sets of numbers, the APR will most likely be higher. This is usually because the loan will require discount points and origination fees upfront.

Overall Thoughts

It is important to be aware of these tiny details before purchasing a home so that you know what you’re getting yourself into. That small difference between monthly interest rate and overall interest rate can better prepare home buyers for their mortgage.

Paying Too Much for Your Mortgage?

If you owe less than $331,760 on your home, use Congress’ mortgage relief program. You may be shocked when you see how much you can save.

Latest Articles

The Ultimate Guide To FHA Streamline Refinance
The Ultimate Guide To FHA Streamline Refinance

If you're looking to refinance your existing FHA loan, then you may want to consider an FHA Streamline. The FHA Streamline Refinance program helps borrowers refinance their current FHA loan more quickly and at a lower rate. It'll also save you from having to fill out...

How the LESA Can Benefit Reverse Mortgage Clients
How the LESA Can Benefit Reverse Mortgage Clients

A Life Expectancy Set Aside, or LESA, is a government-implemented guideline that requires some reverse mortgage borrowers to put aside a portion of their reverse mortgage proceeds to pay for their property taxes and homeowners insurance for a certain amount of time....

Can I Prepay My Reverse Mortgage?
Can I Prepay My Reverse Mortgage?

Most seniors who receive a Home Equity Conversion Mortgage (HECM) intend to make payments only when the loan comes due. After all, one of the primary benefits of a HECM (more commonly referred to as a reverse mortgage) is that you don’t need to start making payments...

What to Do After Closing a Reverse Mortgage
What to Do After Closing a Reverse Mortgage

One of the stipulations in a reverse mortgage agreement is that the borrower is responsible for home upkeep, and to maintain the home at acceptable levels. To ensure this obligation is met, lenders do an initial inspection before the loan is signed to establish that...

Making Monthly Payments on a Reverse Mortgage
Making Monthly Payments on a Reverse Mortgage

The reverse mortgage has plenty of perks that distinguish it from an ordinary loan. While many borrowers appreciate the fact that it is a non-recourse loan that does not require monthly payments, some borrowers still choose to make monthly contributions. Whatever they...

How Reverse Mortgages Affect Medicaid and Medicare
How Reverse Mortgages Affect Medicaid and Medicare

Because a reverse mortgage allows you access to home equity, your income can improve dramatically. Increased income, however, can have an impact on government sponsored programs, specifically Medicaid and Medicare. First the good news–taking out a reverse mortgage...

Pin It on Pinterest