When you’re on the cusp of making one of the biggest financial decisions of your life, it doesn’t hurt to do a little comparison shopping before signing your name on the dotted line.
But where do you turn if you’re faced with a plethora of mortgage loan options, all of which look good and sound good but ultimately may not be the best for you? On top of looking at the interest rate and lender’s fees, you’ll want to pay close attention to the loan’s APR, or annual percentage rate.
Which means what exactly?
In short, it’s a value showing how much it costs each year to borrow money, taking into account the interest rate and other fees involved with the loan. It’s useful, experts say, when you want to compare different loan offers side-by-side.
Of course, like all other mortgage terminology, it can be a chore to comprehend. Good thing we did the heavy lifting for you:
APR vs. interest rate
First, let’s differentiate APR from the mortgage interest rate. They’re not the same.
The interest rate tells you how much you’re charged for borrowing money on your loan and is how your principal and interest payment are calculated. An APR reflects that interest rate, plus other charges and fees, such as discount points and loan origination fees.
That means a mortgage’s APR, expressed as a percentage of the loan amount that’s financed, will typically be higher than the stated interest rate.
Another difference: Once you lock in an interest rate with a lender, the rate doesn’t change unless you use discount points to lower the rate or request a rate increase to offer a credit toward closing costs, says Movement loan officer Dana Meadows.
The APR, however, does change. Because it’s directly tied to fees, the APR you’re quoted at the start of your mortgage loan process might look different from the final APR tallied at closing when all your fees are confirmed, she says.
When will I get it?
Thanks to a federal regulation called the Truth in Lending Act, loan officers have to quote you an APR no more than three days after you complete your loan application.
This will most likely come with your Loan Estimate, a three-page form that breaks down all your costs and fees after you apply for your mortgage.
How do I use it?
Your APR does not affect your monthly payments but gives the clearest picture of how much your loan truly costs.
It’s most advantageous for borrowers seeking conventional fixed-rate mortgages, in which the interest rate and payments remain the same the entire life of the loan.
So how does that help you? We’ll show you in two hypothetical examples, complete with fictional mortgage lenders and make-believe interest rates.
Let’s say you’re back-and-forth between two loans, both of which are 30-year FRMs. Loan A, from a credit union, has a 3.75 percent interest rate. Loan B, from a nontraditional lender, has a 4 percent interest rate.
At first blush, it seems Loan A is the better deal because it has the lower interest rate. But you press “pause” and take a look at each loan’s APR. You soon realize that, with its higher APR, Loan A actually has more fees, which may make it more expensive for you in the long run.
You bet. First, don’t rely solely on APR when comparing home loans.
Here’s why: Some fees associated with a mortgage transaction, such as title fees, credit report fees and appraisal fees, are not included in the APR calculation.
Second, not all lenders include the same fees in their math when estimating your APR, so the percentage can vary from lender to lender.
Third, the APR assumes the loan will be paid off after the full term. Since most homeowners don’t keep their mortgage for a full 15 or 30 years, their APR will probably be higher because points and fees will be spread out over fewer years.
So while an APR is helpful, it’s just one part of your arsenal when you’re ready to make a home buying decision.
Who can help?
Get in touch with a trustworthy loan officer who can walk you through the process.