Refinance: Effective Rate

Effective rate

n effective rate reflects the total cost of a mortgage (closing costs and interest) over the number of years you expect to hold it. It is shown as a percentage of the amount borrowed.

Why use effective rate
An effective rate is a great way to compare the total costs of mortgages.

It shows the total cost of a mortgage
Lenders charge you both an interest rate and lender and broker fees (which includes discount points.)

By looking at either only the closing costs or only the interest rate, you don't see the total cost of borrowing. An effective rate combines the two, so that you can see the cost of the whole package.

It's customer specific

Since an effective rate is based on how long you plan to keep the mortgage, it shows your total cost, not a generic total cost.

For example, you get a $100,000, 30 year fixed rate mortgage and hold it for 10 years and pay $3,000 in closing costs. Although the interest rate is 7.875%, the effective rate is 8.34% since it includes the interest for the 10 years that you expect to hold the loan and the lender and broker fees (including discount points).

$100,000, 30 year fixed rate mortgage




Interest rate	Lender and broker fees	Effective rate


7.875%	$3,000	8.34

What effective rate doesn't do
An effective rate is probably the best way to determine the true costs of a mortgage, but it has two drawbacks:

It's only as good as the inputs
Although it is helpful to see the total cost of a mortgage over the number of years before you refinance or sell the house, if you can't accurately predict how long it will be before the mortgage is paid off, the effective rate will be less accurate.

It's not widely used
Most lenders and brokers do not offer you an effective rate, so you may not be able to use it to compare our rates with the competition.

An alternative
If you want a way to compare our mortgage quotes with other brokers' or lenders' quotes, you can use an Annual Percentage Rate.

While it is not necessarily an accurate calculation of your cost of borrowing (because it assumes that you will hold a mortgage for the full term, which is rarely the case), lenders and brokers are required by law to offer it, so you will always be able to compare apples to apples (although not all lenders and brokers use the same costs in calculating APR).