Shopping for a house is as much a financial exercise as a domestic one. You want a home you can be comfortable in. Yet you need one you can actually afford to buy. And where affordability is concerned, mortgage interest and rates play an important role.
How much do you know about mortgage interest and interest rates? If your knowledge is limited, you could find yourself buying a house you will later regret. On the other hand, being fully knowledgeable about the financial implications of both can keep you out of trouble.
Here are five things to know about mortgage interest and rates, compliments of the realtors at CityHome Collective in Salt Lake City, Utah:
1. Interest Is Your Biggest Expense
Aside from the actual price of a home, the interest paid on a mortgage is the biggest expense home buyers incur. And make no mistake about it, interest on a 30-year mortgage really adds up. For example, paying 3% on a $150,000 mortgage over 30 years will result in total interest payments in excess of $77,000. That is more than half the value of the mortgage itself.
Why is this important? Because the longer you pay on a loan, the more interest you pay. The best way to save money is to keep the term as short as possible. Simple math bears that out.
2. Advertised Rates Are Averages
The advertised rates you see online are not promised or guaranteed. They might not even be actual rates at all. Rather, they are averaged rates based on weekly benchmarks. You are unlikely to get an advertised rate when you apply for a mortgage. You are also not likely to get the lowest possible rate unless your credit is stellar, your debt-to-income ratio is low, and you have a sizable down payment. In short, be prepared to pay more than what you see advertised.
3. Interest Rates and APRs Are Different
Speaking about advertised rates, CityHome Collective reminds buyers that interest rates and APRs are different. The interest rate is an amount of money you pay to borrow, calculated as a percentage of the principal. The APR, or annual percentage rate, is the total amount you will pay for the privilege of borrowing. It includes interest and fees assessed by your lender. That’s why APR is always higher than the interest rate.
4. Interest Is Calculated Annually
Lenders calculate mortgage interest on an annual basis. To make things simple, let us assume you obtained a mortgage at 12%. Every month you would pay 1% interest on the outstanding principal at the beginning of the year. Interest is recalculated each year and applied to your monthly payments. This process is what is known as ‘amortization’.
Common sense dictates you can save money by making extra payments. Every extra principal payment reduces the amount of interest you pay the following year.
5. Mortgage Interest Is Tax-Deductible
Finally, mortgage interest is tax-deductible up to a certain point. You can claim 100% of your mortgage interest payments for the first $1 million in mortgage value. If you bought your home prior to December 15, 2017, you could claim mortgage interest on the first $750,000 in value.
Deducting mortgage interest reduces your taxable income. In other words, paying $1,500 in mortgage interest doesn’t reduce your tax bill by $1,500; it reduces your taxable income by that amount. You still save on your taxes, but not dollar-for-dollar.
Mortgage interest and interest rates play a vital role in determining housing costs. Make sure you thoroughly understand both before you even think about getting a mortgage.