July 16th, 2019 9:28 AM by Jackie A. Graves, President
is an APR? The annual percentage rate, or APR, is how much you'll pay in interest and
other fees when borrowing money (e.g., when you get a mortgage loan
or a credit card). APR can also be considered the total cost for borrowing
money over a one-year period.
other fees" clause is key here. When home buyers get a loan, they often
obsess over the annual rate alone—say, that 5% extra you'll pay every year for
the life of your $300,000 loan. But that's not where your expenses end, and
that's where APR comes into play.
includes the interest rate and other
charges, which is why it's usually higher than just your interest rate,"
says Michele Lerner, author of
"Home Buying: Tough Times, First Time, Any Time."
to think of annual percentage rate as the "true" amount they
pay, because it includes all of the major upfront fees associated with the
loan (e.g., closing costs, points, origination fees, and private mortgage insurance). It's also known
as the effective APR.
The APR is
also your "apples to apples" number when comparing purchase or
refinance loans from various lenders, and keeps you from getting tricked into
paying hidden fees. If one lender has a vastly higher APR for the same
percentage rate, that means it's charging you more for borrowing
money, and you could end up carrying more debt.
There are some costs that aren't usually
calculated into APR, including the home appraisal,
title search, title insurance, credit report,
and transfer taxes.
(Though taxes are usually considered part of closing costs, they aren't a
lender fee so don't count toward the APR.)
the appraisal, credit report, title search, and title
insurance should normally be fairly minor costs when compared with
the cost of the loan. Still, if you're looking at two very close rates, make
sure to examine what's calculated into the APR. Some lenders might not be
including things that other lenders are.
number is more important, the periodic rate or APR? If you want to make sure
you get the best loan for your situation and don't get into too much debt, it's
important to look at both disclosures.
reason you should look at both numbers is that if you just stick to the
interest rate, you may not know about the fees associated with your
loan," explains Lerner. "If you focus only on the APR, you could
miss out on a lower interest rate."
Keep in mind
that the fees that are included in the APR are paid at
closing. In contrast, your interest rate is what you'll pay as
long as you are making monthly payments, which could last as long as 30 years,
notes Stephen Rybak, a senior vice
president with Guardhill Financial in New York.
Your APR does
not include interest compounding. Compound interest is basically "interest
on interest." For example, if you incur an interest charge one month, and
you don't make payments that cover all of the interest expense, you then pay
interest on the higher balance that includes unpaid interest. Interest
compounding is more important to credit card APRs and personal loans, where the
amount of interest you pay to the credit card company or bank may multiply as
the balance goes up.
Even saving a
fraction of a percent on your interest rate can save you thousands of dollars.
As the prime rate (the rate banks charge one another) goes up and down, so do
purchase APRs on mortgages and other debt. If you can purchase a home when you
can lock in a good APR, you'll save a lot of money on interest charges over the
life of your mortgage.
you'll find different APRs from different lenders. Shop around to make sure you
get the best deal.
factors affect the interest rate most mortgage lenders offer at a given time:
score: Your credit score is
a numerical representation of your track record of paying off your debts, from
credit card debt to student loans. If you have a good mix of credit accounts
(e.g., a credit card or two and perhaps an auto loan) and you pay your bills
every month, you generally should have a good credit score. Lenders use your
credit score to predict how reliable you’ll be in paying your home loan. In
general, consumers with higher credit scores receive lower interest rates than
consumers with lower credit scores. A perfect credit score is 850, a good score
is from 700 to 759, and a fair score is from 650 to 699.
amount and down payment: If you're willing and
able to invest a large down payment in your home, lenders assume less risk and
will offer you a better rate. (A 20% down payment makes a lender feel a lot
more secure than a 10% down payment.) If you don’t have enough money to put
down 20% on your mortgage, you will probably have to pay private mortgage
insurance, or PMI, an extra monthly fee meant to mitigate the risk
to the lender that you might default on your loan. (PMI ranges from about 0.3%
to 1.15% of your home loan.) Also, depending on your circumstances or loan
type, your closing costs and mortgage insurance may be included in the amount
of your loan.
location: Mortgage rates can vary depending on where you’re buying a
home. Indeed, the strength of your local housing market can drive up or drive down interest
type: Your interest rate will depend on what type of loan you
choose. The most common type of home loan is a conventional mortgage, aimed at
borrowers who have well-established credit, solid assets, and steady income. If
your finances aren't in great shape, you may be able to qualify for a Federal Housing
Administration loan, a government-backed loan that requires a low
down payment of 3.5%. There are also U.S. Department of Veterans Affairs
loans and U.S. Department
of Agriculture Rural Development loans.
term: The duration of your loan affects your rate. In general,
shorter-term loans have lower interest rates—and lower overall costs—but larger
of interest rate: Mortgage rates depend on whether you
get a fixed-rate
mortgage or an adjustable-rate mortgage (ARM), also called a
variable APR mortgage. A fixed-rate means the interest rate you pay remains
fixed at the same level throughout the life of your loan. Meanwhile, an ARM is
a loan that starts out at a fixed, predetermined interest rate—likely lower
than what you would get with a comparable fixed-rate mortgage—but the rate
adjusts after a specified initial period—usually three, five, seven, or 10
years—based on market indexes.
Having a hard
time choosing between loans based on the interest rate versus APR? If
you have the cash upfront but would prefer to have lower monthly payments, it
might be worth it to you to shop for the lowest interest rate, even if the APR
is slightly higher. In 10 years, you'll be thankful for that lower
interest when you're paying a smaller bill.
On the other
hand, if you need all of your cash on hand for the down payment, you
might need to pay a slightly higher interest rate with fewer fees
at closing. It also matters how long you plan to stay in the house.
has a break-even point, where the extra fees you paid upfront are balanced out
by a lower interest rate. If your break-even point for a loan with a higher APR
and lower interest rate is seven years, but you plan to sell the house in five,
you're getting a better deal with a loan with a higher interest rate and lower
In the end,
to get the best deal on a home loan, you'll want to look at the interest rate,
APR, and any details you can get about what fees have been included (or perhaps
more importantly, not included) in those numbers.
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