An interest rate is a percentage of a loan amount charged by a lender for the borrower to use the lender’s money. Interest is the primary cost of your mortgage.
Interest rates are typically shown as an annual number. A 4% interest rate means you will pay 4% of your loan amount to the lender over the course of a year.
A Simple Interest Rate Example
If you borrow $100 from a friend for one year, at a 4% interest rate, you would pay your friend $104 after one year. You would pay the principal, $100, plus the interest $4 ($100 X 4%). Your friend charges you interest because there is some risk that you won’t pay her back.
You’ll make your mortgage payment every month. If you borrowed $100,000 at a 4% interest rate, your first interest payment would be $333 ($100,000 X 4% annual interest / 12 months).
You will also pay down a portion of your loan amount, the principal, as well every month. On a fully amortizing loan, your payment would be $477. The first $333 would go towards interest and the rest, $144, would go to pay down your principal. After your payment, your loan amount would be $99,856 ($100,000-$144).
Other Mortgage Costs
When you are borrowing money, you should also pay attention to the fees and points that a lender charges. Annual percentage rate (APR) includes interest as well as fees so you can more accurately compare multiple lenders at once. Bundle suggests you also compare the “In 5 years” numbers on the Loan Estimate. The In 5 years numbers give you the total amount you’ll pay in interest and other loan costs over a five year period. This is a dollar amount instead of a percentage which is easier to understand for most home buyers.
Read more on monthly mortgage mortgage payments here.
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Read more Key Mortgage Terms.