Whenever you apply for a mortgage, the federal government requires lenders to disclose both the interest rate on the loan and the annual percentage rate, or APR. For mortgages, the APR is a measurement of the interest you'll pay on a loan after all of the fees and costs are taken into account. This makes it possible for you to compare different loan products with different fees and costs to determine which will cost you the least over the term of the loan.
The mortgage APR measures the net effective cost of borrowing. The APR calculates the annual percentage rate you would pay on the loan once the costs of getting the loan are factored in. Costs included in calculating the APR include points, the origination fee and mortgage insurance premiums. The APR does not take into account factors such as mortgage application fees, late payment charges, title insurance, property appraisals or document preparation.
APR vs. Interest Rate
The interest rate on a mortgage is simply the amount of interest the lender is charging you for the loan. The mortgage APR includes the interest rate as well as other fees and costs. The APR helps you determine how much the total cost of the mortgage will be.
For example, Bank A might offer a 30-year fixed mortgage for $150,000 at 6.5 percent interest and $5,000 in fees, while Bank B offers the same mortgage for 6.25 percent interest and $7,000 fees. Bank A's loan has an APR of 6.83 percent, while Bank B's APR is 6.71 percent. Thus, while the up-front costs of the Bank A loan are lower, the Bank B loan will cost less in the long run.
Knowing the APR will help you compare the real cost of different mortgage loans, but it does have limits. For example, not all of the fees and costs associated with a mortgage are included in the APR. You should always factor in the complete closing costs when deciding which loan to take. In addition, the APR always assumes that you'll keep the loan for the full term.
If you're planning to sell the house or refinance after a few years, a loan with high fees and costs can end up being more expensive that its APR suggests. The APR is most useful for fixed-rate mortgages. This is because the APR on adjustable-rate mortgages is based on forecasts, and these can end up being very inaccurate.
Finding the best loan for your circumstances is not as easy as simply choosing the lowest APR, because everyone's situation is different. For example, you may not have a lot of money to spend up front, so a loan with a higher APR but lower fees up front may be better for you. You may also want to compare the monthly payments you would have to make on different loans. If the monthly payments are similar and you don't plan to keep the loan for more than five or 10 years, a lower APR may not save you any money.
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