Mortgage rates vs APR

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investor1
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Mortgage rates vs APR

Post by investor1 » Mon Feb 01, 2016 6:25 pm

I was looking at Penfed's rates earlier today and comparing a 10 year fixed rate loan to a 5/1 ARM. The listed rates are as follows:

10 year fixed: APR = 3.085%, Rate = 2.750%
5/1 ARM: APR = 3.113%, Rate = 2.375% (first 60 months), 3.375 (next 300 months)

I'm assuming having the ability to pay off the loan within the first 60 months in either case.

I was under the impression that people are willing to sign up for an ARM mainly due to lower rates in the initial months, but comparing the APRs listed, it appears as though the 10 year loan is a better deal. Given the lower APR, my out of pocket would be lower, and given the higher interest rate, I'd be able to deduct a bit more off of my income taxes if I went that route.

Am I missing anything here?

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jimb_fromATL
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Re: Mortgage rates vs APR

Post by jimb_fromATL » Mon Feb 01, 2016 6:50 pm

My guess is you're probably not doing an apples to apples comparison by comparing the same payment per month for both loans.

You'd also need to compare closing costs, but here's how it looks for the mortgage itself:

Per $100,000 at 2.75% the payment to pay off the balance at 2.75% in 60 months is 1785.78 per month for P&I. The total paid would be $107,147 with $7147 interest.

Per $100,000 at 2.375% the payment to pay off the balance at 2.375% in 60 months is 1769.23 per month for P&I. The total paid would be $106,154 with $6154 interest.

The minimum payment is $16.55 less per $100,000 on the lower rate loan. But that's not free money. Every month you don't pay it on the loan is roughly equivalent to borrowing that amount that month and paying interest on it for the remaining number of months in the loan.

If you made the same $1785.78 payment of $1785.78 on the 2.375% loan it would be paid off in 59.41 months. The total paid would be $106,093 with $6093 interest.

Notice that the 2.375% loan costs less total interest either way, but the $16.55 lower payment (per $100k) costs you $61 more interest on the 2.375% loan.

To me it would not be worth the risk of having the rate go up if you decide not to sell within the fixed rate period on the ARM.

jimb

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grabiner
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Re: Mortgage rates vs APR

Post by grabiner » Tue Feb 02, 2016 12:13 am

investor1 wrote:I was looking at Penfed's rates earlier today and comparing a 10 year fixed rate loan to a 5/1 ARM. The listed rates are as follows:

10 year fixed: APR = 3.085%, Rate = 2.750%
5/1 ARM: APR = 3.113%, Rate = 2.375% (first 60 months), 3.375 (next 300 months)

I'm assuming having the ability to pay off the loan within the first 60 months in either case.

I was under the impression that people are willing to sign up for an ARM mainly due to lower rates in the initial months, but comparing the APRs listed, it appears as though the 10 year loan is a better deal. Given the lower APR, my out of pocket would be lower, and given the higher interest rate, I'd be able to deduct a bit more off of my income taxes if I went that route.
The APR is based on the assumption that you hold the loan to its full term. Thus the 5/1 ARM APR amortizes the closing costs over the full 30 years, but it also assumes that you pay the higher rate after the promotional rate expires. If you pay off the loan in five years, you will pay closing costs (probably the same on both loans, unless there are points) and then pay interest at the interest rate for those five years. If you pay off the loan in ten years, the 10-year fixed is probably better, because it avoids the risk that rates will be much higher after the reset.
Wiki David Grabiner

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FiveK
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Re: Mortgage rates vs APR

Post by FiveK » Tue Feb 02, 2016 1:08 am

investor1 wrote:10 year fixed: APR = 3.085%, Rate = 2.750%
5/1 ARM: APR = 3.113%, Rate = 2.375% (first 60 months), 3.375 (next 300 months)

I'm assuming having the ability to pay off the loan within the first 60 months in either case.
If you are going to pay the whole loan in 60 months no matter what, take the 2.375% rate, unless the closing costs are much larger - see jimb's calculations. Otherwise the 10 year fixed does give you the flexibility to invest instead of pre-pay if, for example, inflation becomes high.

betterfinances
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Re: Mortgage rates vs APR

Post by betterfinances » Tue Feb 02, 2016 1:28 am

investor1 wrote:I was looking at Penfed's rates earlier today and comparing a 10 year fixed rate loan to a 5/1 ARM. The listed rates are as follows:

10 year fixed: APR = 3.085%, Rate = 2.750%
5/1 ARM: APR = 3.113%, Rate = 2.375% (first 60 months), 3.375 (next 300 months)

I'm assuming having the ability to pay off the loan within the first 60 months in either case.

I was under the impression that people are willing to sign up for an ARM mainly due to lower rates in the initial months, but comparing the APRs listed, it appears as though the 10 year loan is a better deal. Given the lower APR, my out of pocket would be lower, and given the higher interest rate, I'd be able to deduct a bit more off of my income taxes if I went that route.

Am I missing anything here?
The rate is the number that you are concerned about. That is the actual interest rate you pay on your loan.

The APR number tries to adjust the rate based on the fees for the loan. However, it is nearly impossible to compare APRs because only some fees figure into APR and depending on how lenders structure their fees the APRs may or may not be comparable. I ignore APRs and only look at rates when considering interest. I do look at fees carefully too but study those separately of interest rates.

betterfinances
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Re: Mortgage rates vs APR

Post by betterfinances » Tue Feb 02, 2016 1:32 am

investor1 wrote: 10 year fixed: APR = 3.085%, Rate = 2.750%
5/1 ARM: APR = 3.113%, Rate = 2.375% (first 60 months), 3.375 (next 300 months)
A 5/1 ARM will not have a fixed interest rate at 3.375 percent for 25 years. ARMs are adjustable rate mortgage. They are fixed for the first five years and then float every year thereafter. 3.375 might be the rate that you would pay in 2021 based on today's rates, but it is unlikely interest rates will be exactly the same 5 years from now as they are today.

By getting a 5/1 ARM, you have no idea what rate you will pay in 5 years time. Som lenders put a maximum rate or perhaps a maximum rate of increase, so you might have some protection there.

investor1
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Re: Mortgage rates vs APR

Post by investor1 » Tue Feb 02, 2016 10:26 am

grabiner wrote:
investor1 wrote:I was looking at Penfed's rates earlier today and comparing a 10 year fixed rate loan to a 5/1 ARM. The listed rates are as follows:

10 year fixed: APR = 3.085%, Rate = 2.750%
5/1 ARM: APR = 3.113%, Rate = 2.375% (first 60 months), 3.375 (next 300 months)

I'm assuming having the ability to pay off the loan within the first 60 months in either case.

I was under the impression that people are willing to sign up for an ARM mainly due to lower rates in the initial months, but comparing the APRs listed, it appears as though the 10 year loan is a better deal. Given the lower APR, my out of pocket would be lower, and given the higher interest rate, I'd be able to deduct a bit more off of my income taxes if I went that route.
The APR is based on the assumption that you hold the loan to its full term. Thus the 5/1 ARM APR amortizes the closing costs over the full 30 years, but it also assumes that you pay the higher rate after the promotional rate expires. If you pay off the loan in five years, you will pay closing costs (probably the same on both loans, unless there are points) and then pay interest at the interest rate for those five years. If you pay off the loan in ten years, the 10-year fixed is probably better, because it avoids the risk that rates will be much higher after the reset.
Ah, that makes sense. Thanks to everyone for your replies!

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