APR vs. Interest Rates On Mortgages
When you’re seeking to secure funding for something like a mortgage.
APR and interest rate are just some of the terms that borrowers should understand before signing on a loan. Of course, controlling some factors that dictate your mortgage rate are totally in your power. Snagging a lower rate is all about making yourself appear a more trustworthy borrower.
The Annual Percentage Rate (APR) is the true cost of the mortgage. The APR includes not only the interest expense on the loan but also all fees and other costs involved in procuring the loan. It takes into account all the fees and charges you pay when you receive the mortgage (such as closing costs) and spreads those out over the life of the loan so you can get an idea via an annualized rate of what you’re actually paying.
if you were considering a mortgage loan for $200,000 with a 6% interest rate,
your annual interest expense would amount to $12,000,
or a monthly payment of $1,000.
The Annual Percentage Rate (APR):
Closing costs, mortgage insurance, and Other costs $5,000.
In order to determine your mortgage loan's APR, these fees are added to the original loan amount to create a new loan amount of $205,000. The 6% interest rate is then used to calculate a new annual payment of $12,300.
To calculate the APR, simply divide the annual payment of $12,300 by the original loan amount of $200,000 to get 6.15%.
The scenario most confusing to borrowers is when two lenders are offering the same nominal rate and monthly payments but different APRs. In a case like this, the lender with the lower APR is requiring fewer upfront fees and offering a better deal.
While the interest rate determines the cost of borrowing money, the APR is a more accurate picture of total borrowing cost because it takes into consideration other costs associated with procuring a loan, particularly a mortgage. When determining which loan provider to borrow money from, it is crucial to pay attention to the APR, meaning the real cost of financing.
The use of the APR comes with a few caveats. Since the lender servicing costs included in the APR are spread out across the entire life of the loan, sometimes as long as 30 years, refinancing or selling your home may make your mortgage more expensive than originally suggested by the APR. Another limitation is the APR's lack of effectiveness in capturing the true costs of an adjustable-rate mortgage since it is impossible to predict the future direction of interest rates.
While seeking a mortgage, it is imperative to understand the terminology or else it can lead to making incorrect financial decisions when it comes to what borrowing option is best for your situation.