How to Figure Interest Rates on Mortgages

If you are negotiating for a mortgage loan, you are probably inundated with numbers, many of which are featured interest rates. While wading through all of this, it's important to understand the value of what you are being offered. For instance, the difference between 4.5 percent and 3.5 percent doesn't seem like much, but it can make a five-figure difference in the total interest you'll pay by the end of the loan. Interest is paid only on the unpaid principal balance, so the interest portion of your payment goes down a little each month as the principal is paid down. Let's go shopping for a 30-year mortgage of \$335,000 as an example to illustrate how interest rates affect your mortgage choice.

Review your loan offers and find the annual percentage rate (APR) being offered on each. Let's say you have offers from two lenders for 3.5 percent and 4.5 percent, respectively.

Divide the APR by 12 to get your monthly interest rate. For example: 3.5 divided by 12 is 0.291, or 0.00291 in decimal form.

Multiply the amount of money you are borrowing by the monthly interest rate, in decimal form, to get your first month's interest payment. For example, 0.00291 times \$335,000 is \$974.85. This is not your whole mortgage payment, unless you are being offered an interest-only loan. In a conventional loan, the whole payment will also include a portion toward principal and, if included in the lender's terms, escrow contributions for property tax and homeowner's insurance.

Repeat the process with the other offer. In the example, 4.5 divided by 12 is 0.375 and 0.00375 time \$335,000 is \$1,256.25. The cost difference between the two loans is \$281.40 in the first month alone.

Find the monthly principal and interest payments proposed in your loan offers. In the example, the 3.5 percent loan is offered with a payment of \$1,504.30, and the 4.5 percent loan has a payment of \$1,697.40 per month.

Subtract the smaller payment from the larger payment: \$1,697.40 minus \$1,504.30 is \$193.10.

Multiply the difference by the number of months in the full term of the loans. In the example, 30 years is 360 months, so \$193.10 times 360 is \$69,516. This is how much more the extra 1 percent in interest costs you over the life of the loan.

About the Author

Billie Jo Jannen is a politics and lifestyle columnist in rural San Diego County and a senior copy editor for Demand Media. Her writing and editing career spans 23 years, and she specializes in border and environmental affairs. Jannen's eclectic education includes engineering and horticulture, and she represents the Rural Economic Action League in regional economic development planning.

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