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What Is Annual Percentage Rate (APR)?

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

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Annual Percentage Rate (APR): A Longer Definition

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

The APR calculation was designed to help home buyers compare two or more mortgages.

Suppose a first-time home buyer is considering a 30-year fixed-rate FHA mortgage for their upcoming home purchase and has a Loan Estimate from two or more mortgage lenders. In that case, the mortgage with the lower APR will likely represent the better mortgage offer.

However, in certain scenarios, home buyers should not rely on APR to choose a mortgage lender, including when the home buyer will sell the home, pay off the mortgage, or refinance the mortgage within the loan’s initial term; when the home buyer plans to use an adjustable-rate mortgage; or, when the home buyer’s mortgage requires private mortgage insurance.

In each of these scenarios, the look-back calculation used to find the Annual Percentage Rate (APR) becomes speculative and, therefore, unreliable as a tool for comparison.

Common Question About Annual Percentage Rate (APR)

How does APR differ from the mortgage interest rate?

A mortgage’s interest rate is the cost of borrowing the principal amount. In contrast, the APR reflects the mortgage interest rate plus any additional mortgage fees and loan costs, which may offer a more complete overview of a mortgage’s true cost.

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

With fixed-rate mortgages, the Annual Percentage Rate is constant except when home buyers are required to pay mortgage insurance, the amount of which can change based on the remaining principal and equity percentage. With adjustable-rate mortgages, the APR changes when the loan’s interest rate does.

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

A lower APR may suggest better loan terms, but not always. For example, a mortgage loan with multiple Discount points will show a low APR and ultra-high closing costs, which may not be right for your particular needs or budget.

What kinds of fees are typically included in the APR?

The mortgage APR calculation includes all fees linked to the mortgage, including loan origination fees, mortgage discount points, mortgage insurance premiums, and mortgage-related closing costs. APR does not include attorney’s and title fees, and other costs that would still apply if the buyer paid cash for the home.

How can I use APR when comparing mortgage offers?

To use APR as a mortgage comparison tool, make sure you compare 30-year fixed-rate mortgages and confirm that the mortgage insurance payment schedule is the same if your loan requires it. APR can’t be used to compare adjustable-rate mortgages or loans of different types such as Conventional vs FHA, reliably.

Changelog

  • January 28, 2024: Removed extra sections; Simplied text.
  • October 25, 2023: Original publish date

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

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