Imagine you're shopping for a new car, and the salesperson quotes you two different prices for the same model. One is the sticker price, while the other includes taxes, fees, and other charges.
Which one would give you a clearer picture of the total cost?
The same principle applies when you're shopping for a mortgage. The interest rate alone doesn't tell the whole story – that's where APR comes in. In this comprehensive guide, we'll unravel the mystery of APR and why it's essential for making an informed decision on your home loan.
The APR, or Annual Percentage Rate, is a measure of the total yearly cost of borrowing money, including the interest rate and any additional fees charged by the lender. Unlike the interest rate, which only represents the cost of borrowing the principal amount, APR provides a more comprehensive view of the loan's expenses. This is how you compare offers between lenders.
The interest rate is the percentage of the principal loan amount that the lender charges you for borrowing the money. It's the base cost of the loan, and is typically expressed as an annual rate.
For example, if you have a $200,000 mortgage with a 4% interest rate, you'll pay $8,000 in interest charges for the first year (4% of $200,000).
Unlike the interest rate, APR takes into account all the fees and charges associated with the loan, such as origination fees, underwriting fees, and closing costs. By including these additional expenses, APR provides a more accurate representation of the loan's total cost over the entire term. Typically, the APR is higher than the interest rate because of these extra charges.
When shopping for a mortgage, it's essential to compare APRs from different lenders rather than just looking at interest rates. A lower interest rate doesn't necessarily mean a lower overall cost if the lender charges higher fees.
Even though 6.250% interest rate is lower, the APR being significantly higher proves that the 6.250% is a higher true cost to you.
Ask the lender offering the 6.625% Interest Rate to match the 6.250%, and see the difference then.
Several factors can affect the APR you're offered by a lender. Understanding these elements can help you negotiate a better deal or take steps to improve your chances of securing a lower APR.
Your credit score and credit history play a significant role in determining your APR. Lenders view borrowers with higher credit scores as less risky, which often translates to lower interest rates and fees. So on the other side, a lower credit score may result in a higher APR due to the perceived increased risk.
The loan-to-value ratio (LTV) is the amount of the loan compared to the value of the property you're purchasing or refinancing. A higher LTV is typically associated with a higher APR because the lender assumes more risk if you default on the loan.
Different types of loans and loan terms can also impact your APR. For instance, adjustable-rate mortgages (ARMs) generally have lower initial APRs than fixed-rate mortgages, but the APR can fluctuate over time. Similarly, shorter loan terms (e.g., 15-year mortgages) often have lower APRs than longer terms (e.g., 30-year mortgages).
Remember that the APR is illustrating your overall cost of financing.
While lenders are required to provide the APR for any loan they offer, understanding how to calculate it yourself can be valuable. The formula for calculating APR is:
APR = (Fees + Total Interest) / (Loan Principal) / (Total Days in Loan Term / 365) x 100
To calculate the APR, you'll need to gather information about the loan, such as the principal amount, interest rate, fees, and loan term.
Once you have these figures, you can plug them into the formula to determine the APR.
Keep in mind that lenders may have different fees they charge, not just amounts, so it's essential to compare APRs from multiple lenders to ensure you're getting the best deal.
If you're not comfortable with the math, online APR calculators are available to simplify the process. These tools allow you to input the loan details and instantly calculate the APR, making it easier to compare offers from different lenders if you want to do so that way.
Reputable lenders should be transparent about the fees and charges included in their APR calculations. If a lender is hesitant to provide this information or if the APR seems unusually low compared to other offers, it's a red flag that you should investigate further. Bait and switch tactics aren't allowed, but that doesn't mean it doesn't happen.
Understanding APR is crucial for making an informed decision when obtaining a mortgage. By considering the true cost of the loan, including interest and fees, you can compare offers from different lenders and choose the one that best fits your financial situation.
Remember, a lower interest rate doesn't always mean a lower overall cost, so always prioritize APR when evaluating mortgage options.
With this knowledge you'll be better equipped to navigate the home-buying process, and secure a mortgage that aligns with your long-term financial goals.