Monday, June 1st, 2015
When applying for a mortgage, potential borrowers may consider two terms interchangeable: the interest rate and the annual percentage rate. They sound like the same thing but are, in fact, much different.
The interest rate reflects the base cost of borrowing money and is a percentage of the principal loan amount. For example, the interest rate for a 30-year, fixed-rate mortgage was 3.75% the week ending May 15. In this case, a borrower with a $250,000.00 mortgage would have a $1,157.79 monthly payment. (Payment is amortized using the loan amount and term, but doesn’t include escrow for property taxes or homeowners insurance.)
The annual percentage rate (APR) takes the base interest rate and adds in other costs for getting a loan, including underwriting fees, discount points (prepaid interest), per diem interest and private mortgage insurance. Because additional fees are factored in, the APR is typically a quarter to even half point higher than the interest rate.
The borrower’s monthly payment is still the same, but the higher APR rate reflects the true cost of a loan. This figure gives borrowers a way to compare lenders using both the interest rate and fee structure to see which loan is more expensive.
Not all costs of a mortgage are included in the APR calculation. Fees normally not included in the APR include charges for title insurance, notary, document preparation, home inspection, recording fees, transfer taxes, credit report and home appraisal.
APR doesn’t always tell the whole cost story. Borrowers should keep in mind that some lenders like Keegan may offer a credit to offset closing costs, and that isn’t determined until the rate is locked. The APR also spreads costs across the term of the loan. So the APR won’t reflect the true cost of a 30-year loan paid off in 20 years.
Here are a few more considerations.