Key Takeaways
- APR includes interest rate plus fees, showing true loan cost.
- Use APR to compare loan offers from different lenders easily.
- Lower APR doesn't always mean better deal; consider total costs.
- APR may not reflect actual costs if you refinance early.
Article Summary
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): Explained in Plain English
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.
Common Settlement Statement Items and APR Inclusion
| Settlement Statement Item | Included in APR Calculation? |
|---|---|
| Loan Origination Fee | Yes |
| Discount Points | Yes |
| Title Insurance | No |
| Appraisal Fee | No |
| Mortgage Insurance Premium | Yes |
| Prepaid Interest | Yes |
| Escrow for Taxes and Insurance | No |
Annual Percentage Rate (APR): A Real World Example
Sarah was buying her first home and got two mortgage offers. Both looked good, but they were confusing.
- Lender A offered a 6.500% interest rate with a 7.134 APR
- Lender B offered a 6.500% interest rate with a 5.944 APR.
At first, Sarah thought Lender B was better because the APR was lower. But when she looked at the details, she found something important. Both lenders had similar closing costs, but the second lender was charging $12,000 upfront in "discount points" to get that lower APR. Lender A wasn't charging any points.
Sarah knew she'd only live in her home for about 5 years because of her job, so she took the loan with the higher APR. She wasn't staying in her home for 30 years so paying for those costs wasn't worth it.
Common Questions About Annual Percentage Rate (APR)
Get answers to frequently asked questions about APR, how it differs from interest rates, and when to use it for mortgage comparison.
How does APR differ from the mortgage interest rate?
The mortgage interest rate is the cost of borrowing the loan 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 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 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.
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