Understanding Second Mortgage Rates

DEBTSMART®: Second Mortgage Rate and APR
by Scott Bilker

Scott Bilker is the founder of DebtSmart.com and the author of Talk Your Way Out of Credit Card Debt, Credit Card and Debt Management, and How to be more Credit Card and Debt Smart. Send your questions about money, credit, loans, mortgages, or debt, to him at: Scott Bilker, PO Box 563, Barnegat, NJ 08005-0563 or online at: http://www.debtsmart.com/askscott


Scott,

Why is it a different price for the quoted loan interest rate, my mortgage company Quicken Loans, quoted me 6.55 percent on a second. Then when I get the papers to sign, the APR fair credit paper states 7.1 percent for the interest rate. Is the mortgage company trying to be dishonest and not really give me the rate quoted? I don't understand; please help me. Thank you!

Pam

Thanks for writing in with a math question!

I do so enjoy talking about the math of money because math is the tool you need to uncover the truth about the cost of debt. Math enables you to compare your credit options and avoid being fooled by the banks!

Here it is in a nutshell...

The APR you were originally quoted, 6.55 percent, is the interest rate that the bank uses to charge you monthly on your outstanding balance. That is, 6.55 percent divided by 12 is 0.5458333 percent. Therefore, if your outstanding balance is $10,000, then you will be charged $54.58 in interest at the end of the month, which brings the total balance to $10,054.58.

The 7.1 percent rate in the final paperwork takes into consideration all fees associated with the loan. It is the true interest rate you pay on the loan based on the amount of money you receive versus what you repay. This number is important because it allows you to compare one loan against another, apples-to-apples.

Let's say you want to borrow $30,000 for your second mortgage and the repayment time is 15 years. The interest rate quoted is 6.55 percent, but there are other associated costs like a $315 application fee, $500 appraisal fee, and $200 in legal fees. The total of all these fees is $1,015.

Using my DebtSmart Loan Calculator, a $30,000 principal, for 15 years, at 6.55 percent, gives a monthly payment of $262.16. But here's the deal--you don't get the entire $30,000!

Why?

Because you have to pay $1,015 to get the $30,000! That means you really get to use $28,985. But your monthly payments are still going be $262.16. Since you're actually using less than $30,000, which is the principal used to compute the monthly payment, it's clear that the true interest rate is higher than the quoted rate. To find the true rate you need to ask the question, "What interest rate is used on a $28,985 principal, for 15-years, to arrive at a monthly payment of $262.16?

Again, using the DebtSmart Loan Calculator, you will find that rate to be 7.1 percent.

So the bottom line is that they're not lying to you. They're fulfilling the legal obligation to compute the true interest rate with all fees included.