What Is the "Price" of a Mortgage?
December 4, 2000, Revised January 20, 2011

"I’m a first-time home buyer shopping for my first mortgage and find myself confused about what I’m shopping for. I understand interest rates (I think), but I also hear about fully-indexed interest rates, points, rebates, origination fees, junk fees, maximum interest rates, and margins. Please sort this out in a way I can understand."

I'll try.

Interest rate is the number that is multiplied by the loan balance to get the interest payment due the lender. The rate quoted on a mortgage is an annual rate, but it is applied monthly. On a 6% mortgage with a $100,000 balance, for example, the monthly interest due is .005 times $100,000, or $500.

On a fixed-rate mortgage (FRM), the interest rate is preset for the life of the loan. On an adjustable rate mortgage (ARM), the rate is preset for an initial period, ranging from 1 month to 10 years, and then can change. Read Fixed Rate Mortgages (FRMs).

Points are upfront charges expressed as a percent of the loan amount. Two points amount to 2% of the loan.

Points are related to the interest rate. If a lender offers a 30-year FRM at 8% and zero points, for example, he might charge 1.75 points for a 7.5% loan. Read Questions About Points.

Rebates are points paid by (rather than to) the lender for high-rate loans. The lender who charges 1.75 points for a 7.50% loan, for example, might rebate 2 points for a 9% loan. The 2 points would be available to defray the borrower’s settlement costs. Read Can Mortgage Points Be Negative?

Origination fees are points in disguise. Some lenders charge origination fees because reporting services and newspapers show rates and points but not origination fees. The lender who charges 1 point and a 1% origination fee looks cheaper than the lender who charges 2 points and no origination fee. To the borrower, points and origination fees are the same. Read Why Origination Fees?

"Junk fees" is a nasty term sometimes used to describe all other upfront charges by the lender or mortgage broker. Junk fees are expressed in dollars rather than as a percent of the loan. What Are Mortgage "Junk Fees" contains a long list of items that some lenders may charge for, but for the borrower shopping the market, only the total matters.

In sum, the price of a fixed-rate mortgage has three components: interest rate, total upfront charges expressed as a percent of the loan, and total upfront charges expressed in dollars. This does not include fees charged by third parties for services that lenders  may require, such as title insurance.

Adjustable rate mortgages (ARMs) have the same price components as FRMs, plus a raft of others.

The quoted interest rate on an adjustable rate mortgage (ARM) is referred to as the initial rate because it is fixed only for a specified period, which can be anywhere from one month to 10 years. At the end of the initial rate period, the rate is adjusted to equal the value at that time of an interest rate index plus a margin, which is specified in the note. This and all subsequent rate adjustments are subject to adjustment caps that limit the size of rate changes, and to maximum rates and minimum rates over the life of the loan.

In sum, the "price" of an ARM includes the initial rate, index, margin, adjustment caps, maximum rate and minimum rate.

The current value of the index, as opposed to the future value used when the rate is adjusted, is sometimes added to the margin to give what is called the fully indexed rate, or FIR. The FIR indicates what will happen to the rate at the  first adjustment if the market rate does not change. For a discussion of the FIR, see What Is the Real Price of an Adjustable Rate Mortgage?

For a description of ARM pricing in more detail, read How Do Adjustable Rate Mortgages Work?
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