Homebuyers often search The lowest mortgage interest rate, but another number – the annual percentage rate, or APR – is important to decide how much home you can buy.
Brian Sherman, a consumer lending executive with Bank of America, says the difference between the interest rate and APR is simple.
The interest rate is the annual cost of borrowing the original loan amount, expressed as a percentage, and does not include all the fees you would pay for the loan. “The interest rate is going to drive that monthly payment,” says Sherman.
In contrast, the APR is the annual cost of the loan, including fees. APR reflects the true cost of borrowing, which is why it is often higher than the interest rate.
Knowing the interest rate and APR for a loan can be helpful when shopping for a mortgage. But because APR is a comprehensive measure of cost, it can be a particularly useful measuring tool, Sherman says.
“Many times for a consumer, a better valuation of annual percentage rate transactions and the deal they are getting,” he says.
How can you compare mortgage interest rates and APRs between lenders?
A quick way to compare interest rates and APRs between lenders is to see loan estimates from them, says Joe Zibert, managing director of Global Mortgage Solutions at Nomis Solutions.
“Loan estimates are standard for all lenders,” says Zibert, who helps top global lenders with mortgage pricing and strategy. “This is a government document that will look similar.”
You will find the interest rate on the first page of the loan estimate; APR is on the third page. Sherman says looking at APR is often the best way to find out which lender is offering the best deal.
“If (lenders) wanted to compare apples to apples, they would compare APR to what one lender called them vs. APR that the other lender quoted them to,” he says.
In many cases, an interest rate that appears attractive may be lower, as the borrower looks at APR.
Sherman cites the example of a lender who charges 4% interest with no points and another who charges 3.875% with a discount point, which typically costs 1% of the loan amount. The first loan may be a better deal, even if the interest rate is higher.
“Even if my rate is high, my APR may be low,” Sherman says.
Does APR provide full images?
APR cannot capture at all costs. For example, your loan estimate may not include a title exam or property survey.
“Make sure you look at those loan estimates and go all the way down,” Zibert says.
The line items will match perfectly, allowing you to easily compare and see how much a lender may charge you.
If you are shopping for an adjustable rate mortgage, APR has drawbacks as a measuring instrument.
Do not compare the APR of a fixed rate loan with the APR of ARM. The ARM’s APR may fluctuate, and the loan estimate will not reflect the highest possible interest rate.
You also cannot trust how interest rates may rise or fall during your loan term. But you can calculate the APR for the initial fixed term of the loan, such as the first five years of 5/1 ARM.
APR can be misleading if financial hardship means you need it Defer mortgage payment. If your interest rate remains the same, but the total amount due increases, then a longer loan reduces your APR.
The longer you pay, the lower the impact fee on APR.
Is a lower interest rate or a lower APR better?
The answer to this question depends on what is more important to you: the lowest possible monthly mortgage payment or the lowest possible total loan cost.
Pay attention to the interest rate. APR if monthly payment is your priority and overall loan cost is your concern.
If you plan to stay in your home for 30 years, a low interest rate may be the most important factor. You may be willing to pay points that reduce your interest rate but increase your APR.
“I want the rate to be lower because I’m going to stay in this house longer,” says Zibert.
Sometimes it doesn’t make sense, though. “You say that if you are going to transfer in a year, you don’t want to pay an extra $ 5,000 (in digits) to lower your rate.”