Borrowers fixate on rate. The rate is the most visible number in the transaction and the easiest to compare across lenders. But rate alone does not tell you the cost of a loan. Total loan cost includes origination fees, discount points, third-party costs, and the cumulative interest paid over the time the borrower actually holds the loan.
The Components of Total Loan Cost
- ✦Origination fees: lender charges including origination points, underwriting fees, and application fees
- ✦Discount points: prepaid interest that reduces the rate; each point is 1% of the loan amount
- ✦Third-party costs: appraisal, title, escrow, attorney, recording, and other fees that vary by transaction and geography
- ✦Monthly payment: the sum of principal and interest over the hold period
- ✦APR: the federal disclosure metric that annualizes the total cost including fees, but it assumes a 30-year hold and understates cost for shorter hold periods
Why APR Misleads Short Hold Borrowers
APR is calculated assuming the borrower holds the loan for the full term, typically 30 years. If the borrower sells or refinances in 5 years, the APR calculation overstates the benefit of paying points to reduce the rate because the upfront cost is spread over 30 years in the APR formula but only recovered over the actual 5-year hold. For borrowers who hold less than 7 to 10 years, a lower-fee loan with a slightly higher rate often has a lower total cost than a low-rate, high-point loan.
How to Build a Total Cost Comparison
- ✦Step 1: Identify the borrower's expected hold period (purchase: how long do they plan to stay; refinance: when will they sell or refinance again?)
- ✦Step 2: Calculate all upfront costs for each option (origination fees plus points)
- ✦Step 3: Calculate monthly payment difference between options
- ✦Step 4: Divide the upfront cost difference by the monthly payment difference to get the break-even month
- ✦Step 5: If the break-even is beyond the expected hold period, the lower-rate option with higher upfront cost is not worth it
Comparing Across Lenders on Total Cost
- ✦Request a Loan Estimate from each lender for the same loan amount, LTV, and credit tier
- ✦Compare Section A (origination charges) across lenders: this is the lender-controlled cost
- ✦Add Section A to any discount points and compare the total lender cost alongside the rate
- ✦Third-party costs in Sections B and C may vary slightly but often reflect local market rates, not lender choices
Aria can build a total cost comparison for multiple loan scenarios including break-even calculations and hold-period sensitivity. Ask at vicariointel.com.
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