Like any large purchase, you’ll want to shop around for the best mortgage that you can find. But, you must make sure that you compare apples to apples when you look at the interest rate for your mortgage.
Mortgage lenders typically show two different interest rates to borrowers, the mortgage interest rate and annual percentage rate, or APR. Understanding the difference between each rate and ensuring that you’re comparing the same rates across all of the mortgages you’re considering could save you thousands of dollars over the long term.
Your APR measures additional important, but different, costs that lenders add to your home loan. It’s important to understand how lenders calculate an APR for your mortgage and how it compares to the simple interest rate.
What Is APR?
The interest rate that lenders advertise for a mortgage is simply the cost to borrow the principal loan amount for your home. It doesn’t include any fees from the lender, and the interest rate can either be variable or fixed. The interest rate lenders charge customers depends on several factors like your loan type, loan length, down payment, your credit score, and other factors. The interest rate is the base fee and always stated as a percentage.
Understanding your interest rate is very important because it directly affects monthly payments, unlike your APR. The interest rate is one way to compare mortgages from multiple lenders, but it does not factor in all of your costs.
The annual percentage rate, or APR, shows the true cost of your mortgage. It is the total cost expressed as a percentage. The APR includes the interest rate plus and adds any upfront costs or fees that you must pay to the lender. Lenders often charge points, fees, or other costs to borrowers in order to receive a lower rate or to even close on a deal. The APR is a more encompassing measure of the true cost of your mortgage since it includes other costs like discount points, closing costs, and brokerage fees in addition to the simple mortgage interest rate.
APR helps consumers understand the comparisons between interest rate and the fees they pay at closing. Borrowers may typically find mortgages with higher upfront fees in exchange for lower interest rates. Or lenders like to increase an interest to cover closing costs. These higher fees essentially hide the closing costs within them, and consumers must look at the APR to get the full picture of what they are paying. The government, through the Truth in Lending Act, requires lenders to show borrowers the APR next to the interest rate.
Why Lenders Talk About APR
Lenders talk about APR because they have to. It’s the law. The Truth in Lending Act requires that lenders disclose credit terms so consumers can easily compare multiple loans with different credit terms and make an informed decision for the best mortgage that meets their needs.
Before Truth in Lending Act, it was difficult for borrowers to accurately compare mortgages because lenders did not present their interest rates the same way. The law now requires that mortgage company show loans with the same terminology and interest rate calculations. Consumers can now look at the APR of mortgages as a single means of comparison.