If you’ve ever compared mortgage documents, you may have noticed two percentages listed—an interest rate and an APR. It’s important to know the difference between these two rates so you can choose the best deal. Here’s what you need to know about mortgage interest rates and APR—not understanding the difference could cost you a lot money.
How Lenders Calculate APR
The interest rate is the current cost of borrowing money. The APR (or annual percentage rate) is the full cost of the loan, INCLUDING all the fees the lender charges for financing the loan. These include most of your closing costs, mortgage insurance, loan origination fees, any discount points, and charges like mortgage insurance and funding fees.
The APR reflects your entire cost for the loan, so it will almost always be higher than your interest rate.
How to Compare Loans
Now, let’s put this into practice. Let’s say you have these two loan offers:
It’s easy to see that the first loan is a better deal. But since these loans are so similar (the only difference is the fees charged by the lender), you can see which one is a better deal without even looking at the APR.
But what about a more complicated scenario? Let’s compare these two loans:
Here, the loan with the higher closing costs is the better deal. It’s the one with the lowest APR. In this case, APR is the only way to get the true cost of the loan because it takes into account both interest rate and the fees you’ll pay.
Use a mortgage calculator if you want to do these calculations yourself.
Should You Always Get the Loan with the Lowest APR?
Believe it or not, you shouldn’t necessarily choose the loan with the lowest APR. If you’re going to be paying the full 30-year mortgage, then there’s no doubt that the loan with the lowest APR is the best choice. But things might chance if you don’t plan to stay in your home that long.
These are the exact same loan options as in the previous example, but this time, they’re only for 5-year terms (rather than 30-year terms). Now the first loan, with just $1,000 in closing costs but a higher interest rate, is the better choice. The APR is just 5.27% rather than 5.6% for the second loan
A low APR is great if you’re paying off the mortgage over its entire term. But you’re not, the upfront costs of getting the mortgage are spread over a shorter period of time, which changes the real cost of getting the loan.
If you’re only planning on staying in a home for a few years, or if your timeline is very uncertain, you’re probably better off taking the loan with the lowest closing costs and paying the higher interest rate.
I hope this answers any questions you might have about APR when you’re shopping for a mortgage. If you have any other questions or concerns (we know loan shopping can be complicated!) give us a call at (503) 528-9800. We’ll be happy to help you out!