INTEREST RATES ON REAL ESTATE LOANS DEFINED
Earl L. Huse, JD
May 02, 2009
An interest rate therefore, is the percentage of an amount of money, which is paid for its use for a specified time. Usually expressed as an annual percentage rate. These percentage rates can be different from lending source to lending source depending on many factors.
There are a few different types of Interest rates, which can be confusing to the consumer if they do not have a basic understanding of the various types. They are:
INITIAL INTEREST RATE: This refers to the original interest rate of the mortgage at the time of closing. This rate changes for an adjustable-rate mortgage (ARM). It's also known as "start rate" or "teaser."
INITIAL NOTE RATE: The note rate on an adjustable loan at its inception. Beware of initial note rates that are abnormally low (less than 1% below FNMA rates for fixed mortgages).
INTEREST EXTRA NOTE: A note stating an equal (usually monthly) payments on principal, plus interest. As the interest decreases (based on declining principal balance) the total payment decreases. The amount applied to principal remains the same.
INTEREST INCLUDED NOTE: A note having equal payments (usually monthly). Interest is figured on the declining principal balance. As the principal decreases, interest also decreases, applying more of each payment to principal.
INTEREST ONLY LOAN: A loan on which only interest is payable during the term of the loan, with the principal at the end of the loan term.
INTEREST: Money paid for the use of money. Interest is the periodic charge for use of credit.
Lender can change interest rates on a daily bases and are determined on such thing as what are the bonds doing, what is prime interest rate, and so on. I will not attempt to explain the economic factors that alter the daily rates in a very complex real estate marketplace. Rate quoted to you today may not be the same as they were yesterday, and for sure not the same in a few weeks as they are today.
The interest rate quoted to you can be different from lender to lender and are based on some of the following:
A) Type of loan (FHA, VA, conventional, Non-Conforming, Investor ((Portfolio))
B) Size of loan (conforming-non-conforming ((Investor)) multi-units, etc.)
C) Fixed rate, Adjustable Rate Mortgage (ARM), Balloon or Convertible type loan.
D) Creditworthiness (excellent credit, good credit, etc. See
E) Underwriting guidelines from lender to lender
F) Qualifying
G) Term of the loan (10 years, 15 years, 20 years, 25 years, 30 years, 40 years, and 50 years)
One item to keep in mind when obtaining interest rate quotes is if you want some of the closing costs to be paid by the lender. If you do, then the loan points (the cost of borrowing money) increased to offset those closing costs you would normally pay.
A) A point is the term used to describe the percentage of discount rather than interest (for which the word "percentage" is used) and represents one (1%) percent of the loan amount in costs. As an example: On a $100,000 loan amount with a 1% discount (one point) it would equal $1,000.00 in charges. Points are paid either by buyer or seller in a conventional loan, and pay by the seller in FHA and VA loans Once the interest rate has been selected by you (agreed upon, but not locked in yet by the lender) you need to know what the monthly mortgage payment is going to be. A mortgage payment includes the repayment of the interest rate (the amount expressed in interest percentage for the use of the borrowed funds from the lender) and the principal balance (the amount you actually borrowed). This amount is referred to as Principal and Interest (P&I).
Monthly mortgage payments depend on different factors, such as the size of the loan (amount borrowed) term of the loan (years to repay the loan) and interest rate (is the loan a fixed rate or an adjustable rate mortgage). To illustrate the mortgage payments, an example would be as follows:
Loan Amount Interest Number Monthly Payment Rate of Years (P&I pmt. only)
100,000.00 7% 30 years $ 685.30
100,000.00 7% 15 years $ 898.83
The principal and interest is not the only monthly payment associated with homeownership, and are not the only payments used to determine the qualifying debt ratios. Additional payments include property taxes; hazard insurance, private mortgage insurance (PMI) and Homeowner Association Dues. These payments are paid by the borrower and held by the lender in a separate escrow account on your behalf and as the accounts become due the lender pays them. In the case where the lender does not "escrow" the account, the borrower must have the funds available to pay them as they become due (monthly HOA dues, insurance, property taxes, annually insurance).
Once you have satisfied yourself that the total expense (Principal, Interest, Taxes & Insurance ((PITI)) and total miscellaneous expenses) of home ownership is within your budget, you now need to determine how much of a home you can qualify for. As a general rule of thumb, (and as a general guideline only) you can afford to purchase a home that costs approximately two and one half times your gross annual income (gross income is all household annual income before any taxes that is going to be used to qualify for the loan ((include your spouse if a co-borrower)). As an example: Combined annual gross income of borrower(s) is $50,000, multiplied by 21/2 times would equal an approximate purchase price of $125,000.
Another way to determine your qualifications for home purchase are using the basic debt ratio (Front-end-ratio) which uses the borrower´s combined total monthly gross income (as an example $3,500.00) and multiply the income by the front-end debt ratio factor. $3,500.00 times 26% equals $910.00 or the maximum PITI allowable for a conventional loan greater than 80% loan-to value.
There are other factors considered in the loan approval process while the above information is only a basic guideline, it will assist you in determining what type or term of a loan is best for you.
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