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Step 1
Understand that the important result in mortgage calculation is the total number of dollars paid in interest and principal during the life of the loan. Loans have three functions that each must be analyzed for comparative analysis. Compute total dollars paid by multiplying the length of the mortgage by the annual amount of dollars paid. Add any upfront fees or points that are charged at the time of closing.
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Step 2
Calculate the annual percentage rate -- or APR -- of the mortgage. Use the mortgage calculator listed below in Resources. The APR reflects the effect of upfront payments or points and the interest rate charged. It does not take into account the number of years the payment must be made. Use the APR to find the lowest annual rate you will pay. Longer mortgages, because of the time risk, usually have a higher APR. The effective rate is what you actually paid if you made prepayments.
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Step 3
Understand that the difference between a 15- and a 30-year mortgage is the same as one additional monthly payment per year. The payment is applied to principal and reduces the outstanding debt accordingly. Know that a 15-year mortgage may lock you into bimonthly payments or large monthly payments. Consider whether you are better off making extra payments on a 30-year mortgage with a higher long-term rate or getting the lower 15-year rate with more demanding terms.
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Step 4
Demand that any mortgage you purchase have early prepayment terms without penalty. Know that any mortgage should be replaced by a lower-rate mortgage if there is a 1.25 percent interest rate savings. Use the interest savings for prepayment on the new mortgage, and reduce the number of years the new mortgage is outstanding.
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Step 5
Use the marginal tax rate you pay to calculate the amount of tax savings. Recalculate the after-tax rate you will pay on your mortgage. Understand that the difference in marginal tax rates is lower than the quoted rate or the APR. The after-tax rate is the real cost of money to you. After-tax will show that the difference between a short fixed-rate mortgage and a long rate is not very substantial. This reward must be measured against the higher payments you must make to amortize a short mortgage.
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Step 6
Use the mortgage calculator to understand the mix of rate, maturity and prepayment. Realize that the shorter number of years you are paying on the mortgage results in lowering the effective interest rate you will pay and the smaller amount of dollars that left your pocket.
