What Is Annual Percentage Rate (APR)?

Annual Percentage Rate (APR) is a calculation that represents the complete cost of a mortgage held to its full term, expressed as a percentage.

Annual Percentage Rate (APR): A Longer Definition

Annual Percentage Rate (APR) is a government calculation based on the total payments a home buyer would make over time if the mortgage is held to its full term. It includes mortgage interest, closing costs, insurance premiums, and other loan-related expenses.

The APR calculation helps home buyers compare two or more mortgages, but it should not be the only factor in making a decision.

For example, if a first-time home buyer is considering a 30-year fixed-rate FHA mortgage and has a Loan Estimate from two or more lenders, the mortgage with the lower APR may seem like the better offer. However, it is important to consider all aspects of the mortgage, such as upfront costs and how long the buyer intends to keep the loan.

There are cases when home buyers should not rely solely on APR, such as when the buyer plans to sell the home, pay off the mortgage, or refinance within the loan’s initial term, or when using an adjustable-rate mortgage, or when private mortgage insurance is required.

In these situations, the APR calculation may not reflect the actual cost of the mortgage over time, since it is based on assumptions that might not hold true in the future.

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Common Questions About Annual Percentage Rate (APR)

How does APR differ from the mortgage interest rate?

The mortgage interest rate is the cost of borrowing the loan’s principal amount. The APR, on the other hand, reflects the interest rate plus additional fees and loan costs, offering a more complete picture of the loan’s cost. However, remember that it is not the only measure of affordability.

Can the APR change after I’ve secured a mortgage?

For fixed-rate mortgages, the APR remains constant unless mortgage insurance is required, which can change based on the loan’s principal and equity. For adjustable-rate mortgages, the APR changes when the interest rate does.

Is a mortgage with a lower APR always a better option?

A lower APR might suggest better terms, but not always. For example, a mortgage with several discount points may show a lower APR but higher closing costs, which may not fit your budget or needs. A mortgage with a higher APR but lower upfront costs could be better depending on your financial situation and how long you plan to keep the loan.

What kinds of fees are typically included in the APR?

Mortgage APR calculations include loan origination fees, discount points, mortgage insurance premiums, and closing costs. It does not include attorney or title fees, which would apply even if the buyer paid in cash.

How can I use APR when comparing mortgage offers?

To compare APRs effectively, ensure you’re comparing similar loans, such as 30-year fixed-rate mortgages, and verify that the mortgage insurance payment schedules are the same if applicable. APR is not useful for comparing adjustable-rate mortgages or different types of loans, like conventional versus FHA.