Mortgage Rate Vs APR | Why You Should Know The Difference
When you decide to get a mortgage, you’ll want the best deal possible. Unfortunately, shopping for home loans means comparing dozens of numbers against each other.
Lenders will try to showcase their best and lowest interest rates, but that doesn’t mean they’re more affordable – high fees can drive up the cost. Understanding the difference between mortgage interest rate and annual percentage rate (APR) will guarantee you get the best option and are not duped from the get-go.
Read our guide to learn everything you’ll need to know about APR vs interest rate!
What Is A Mortgage Interest Rate?
The first figure you’ll see when you’re looking for a home loan deal is the mortgage interest rate. An interest rate is the cost of borrowing money, expressed as a percentage rate. This amount does not include other fees you’ll have to pay when you take out the loan.
An interest rate will usually be expressed as an annual rate, but you typically pay interest along with your monthly payment for your mortgage loan. With every payment, you slowly pay back the principal amount that you borrow (building home equity), plus what your lender is charging for lending you the amount, which would be the interest rate. Because this interest is added to every payment you make, the longer you keep a mortgage loan, the more you’ll be paying in the long run.
For example, take two loans with the same principal – one for 10 years and the other for 20. If you take on a larger monthly mortgage payment for the 10-year loan, you end up paying less money overall. This is because what you pay for the interest rate adds up. The longer you have to make monthly mortgage payments, the more you’ll have to keep paying that interest rate for the loan.
Interest rates are often influenced by the federal fund rate, which is set by the Federal Reserve. This number only changes several times a year, depending on the economic situation. In times of growth, interest rates are slowly raised in order to balance cash flow. In times of recession, rates are lowered to encourage spending.
The interest rate given to you might also be affected by personal factors, including your credit score, term length, type of mortgage, etc.
What Is A Mortgage APR?
A mortgage APR or annual percentage rate is comprised of the loan’s interest rate plus all other fees or costs involved. This figure is also expressed as a percentage. A loan’s APR should be at least equal to or more than your interest rate, except on special occasions where your lender might offer rebates on part of the cost of your interest.
Since the APR includes all costs, it is often the better figure for judging a loan. With the APR, you can get a better and more accurate picture of the total cost of borrowing money for a home.
However, because a loan can span up to 30 years, it’s impossible to determine the true amount of money you may end up paying. This is especially true with adjustable-rate mortgages since there’s no way to predict future rates – the APR does not reflect the maximum interest rate of the loan.
It’s also important to note that it may not be accurate to compare the APR of one type of loan, such as a fixed-rate loan, to the APR of another, such as a closed-end loan.
When you compare loans, it’s a good idea to ask the lender what costs they include in their APRs. You won’t typically find that two lenders will include the same set of costs in an APR. If you’re trying to choose between loans, asking for this information will allow you to make a more informed and accurate decision.
These are an example of what charges the federal law states that your lender should and should not include in an annual percentage rate:
Fees Included In A Mortgage APR
- Interest
- Points
- Loan origination fee
- Broker fees
- Closing costs
- Mortgage insurance
Loan rebates, discount points, prepaid interest, loan application cost, underwriting, and lender fees may also be included.
Fees Not Included In A Mortgage APR
- Agent’s document preparation
- Property tax
- Homeowners insurance
- Notary fees
- Home Appraisal
- Pest and flood inspection
- Escrow agent fees
- Attorney Fees
- Government-imposed recording charges and property transfer tax
Should You Use APR To Compare Mortgage Loans?
Though APR is a broader, more accurate figure than an interest rate in evaluating loans, there are other ways to compare which offers are best. This is because, in reality, most people won’t stick to an initial deal all the way to the end.
More often than not, people sell or refinance houses every few years. A loan with a lower interest rate and higher APR initially may actually be cheaper than a loan with the same or higher interest rate and lower APR if you’re only planning to keep it for a short period.
The best thing to do is use a calculator (like the one below) or hire a professional. This will help you determine the total loan amount you’ll end up paying and determine which offers suit you best, based on how long you want to keep and pay for the loan. You may want to plan for uncertain variables, such as changes in your personal life or financial situation.
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That being said, APRs provide very important information to consider and can be used as a way for you to make sure you are not falling for false advertising. If a mortgage offers an interest rate that looks too good to be true, you can check out the APR in its terms to make sure lenders are not making up for the lower rate with higher charges.
The Bottom Line
Getting a mortgage is a huge milestone in your personal finance journey, so you’ll want the best offers possible. Understanding what an interest rate and APR are and how they are different can help you compare deals more effectively.
Remember that just because a deal has a lower interest or APR on paper, that doesn’t always mean that its terms will suit your situation. By knowing how interest rates and APRs can help you determine the loan amount, you can make sure you are getting a deal with a lower cost and a monthly payment amount that won’t break the bank.
If you’re unsure of where to start, consider consulting with a professional to help you sort out your personal financial situation. Our team at Wesley LLC can get you all the information and assistance you need. Contact us now!