March 31st, 2018 8:33 AM by Jackie A. Graves, President
could end up paying thousands of dollars more to finance a home purchase if you
don’t understand the difference between the interest rate and
percentage rate (APR) of a mortgage. Most homebuyers don’t know
that the interest rate and the APR measure two separate costs of a home loan.
rate and APR
interest rate is the cost of borrowing the principal loan amount. It can be
variable or fixed, but it’s always expressed as a percentage. An APR is a
broader measure of the cost of a mortgage because it includes the interest rate
plus other costs such as broker fees, discount points and some closing
costs, expressed as a percentage.
payment vs. overall cost
main difference is that the interest rate calculates what your actual monthly
payment will be,” says Sean O. McGeehan, a mortgage sales manager in Chicago.
“The APR calculates the total cost of the loan. A consumer can use one or both
to make apples-to-apples comparisons when shopping for loans.”
example, a loan with a 4 percent rate will have a lower monthly payment than a
loan with a 6 percent rate, assuming both are fixed for the same term.
Likewise, the total cost of a loan with a 4 percent APR will be less than one
with a 6 percent APR.
determines which number matters more
should be able to use both percentages to determine their total costs. The
trick, McGeehan says, is to understand the interplay between the two figures.
a consumer is only focused on getting the lowest monthly payment, they should
focus on the interest rate,” McGeehan says. “But if the consumer is focused on
the total cost of the loan, then they can use the APR as a tool to compare the
total cost of two loans.”
chart compares the interest rate, APR and total costs over time for a
$200,000 mortgage in which 1.5 discount points cut the interest rate
by a quarter of a percentage point, and another 1.5 discount points cut the
interest rate by another quarter of a percentage point.
$200,000 mortgage with different rates, APRs
Points and fees
All costs, 3 years
All costs, 10 years
All costs, 30 years
you plan to stay in your home for 30 years or more, it makes sense to take out
a loan that has the lowest APR because you’ll end up paying the lowest amount
possible for your house. But if you don’t plan to stay in the house that long,
it may make sense to pay fewer upfront fees and get a higher rate — and a
higher APR — because the total cost will be less over the first few years.
APR spreads the fees over the course of the entire loan, its value is optimized
only if a borrower plans to stay in the home throughout the entire mortgage,”
says Gloria Shulman, founder of CenTek Capital Group in Beverly Hills,
the break-even point
you’re planning to stay in your home for a shorter period, you need to do the
math and determine your break-even point.
Bankrate’s mortgage points
calculator will help.
example, if you chose a 0.25 percent lower rate for an additional 1.5 points
because of the lower APR, but you moved in five years, you lost money. Your
break-even on the points was seven years.
those calculations are often confusing to most homeowners, which is why it’s
important to choose the right lender.
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