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The terms, interest rate or annual percentage (APR), are often used interchangeably, but they aren’t quite the same. It’s not uncommon for buyers to focus on the interest rate, but the APR, or annual percentage rate, is also a key term to understand if you’re shopping for a mortgage or looking to refinance. Like the interest rate, the APR represents the all-in yearly cost of the loan. It also includes some, but not all, other fees you’ll have to pay when you get a mortgage.
What are APR fees?
“When looking for a mortgage it is necessary to compare the APR for the same type of loan, understand all the fees, and to make sure the mortgage payment aligns with your financial goals,” says Judy Brown, senior financial adviser at Berman McAleer in Timonium, Maryland.
Don’t confuse the APR with the interest rate, though. Although they are both percentages, the interest rate is the cost of borrowing before including the fees and other charges. Since the APR includes these additional fees, the APR is always higher than the interest rate.
It can be helpful to think of the interest rate as the rate the lender uses to calculate the monthly interest on your mortgage. The APR, on the other hand, includes both the interest rate and some of the fees you pay, so it’s meant to be a truer reflection of the total cost of the loan.
When comparing mortgage offers, you can find the APR on the loan estimate document provided by your lender, on page three in the “Comparisons” section.
Keep in mind, though, that not all charges are always included.
“Unfortunately, lenders are not required to include all fees in their calculation of APR,” says Ben Simiskey, director of wealth management at Stegent Equity Advisors in Houston, Texas. “So, it’s important for the borrower to clarify with prospective lenders exactly what fees they are including in their APR calculation.”
Here’s a closer look at what fees are typically included in APR and what isn’t.
What fees are included in APR?
Mortgage lenders generally include the following fees in their APR calculations:
- Discount points
- Mortgage broker fees
- Transaction fees
- Mortgage insurance
- Application and processing fees
- Prepaid interest
- Escrow and settlement fees
- Document preparation fees
- Legal fees
- Origination fees
- Mortgage underwriter fees
- Certain closing costs
What fees are not included in APR?
Here are some fees related to a mortgage that aren’t usually included in the APR calculation:
- Title examination fees
- Title insurance fees
- Property survey fees
- Document preparation fees
- Notary fees
- Credit report fees
- Property appraisal fees
- Transfer taxes
- Pest inspection fees
- Flood hazard inspection fees
Does APR include closing costs?
Yes, APR does include most closing costs you’ll incur when buying a new home. You can find a breakdown of these costs on page three of the loan estimate provided by your lender prior to closing.
Example of APR fees
Say Nico makes an offer on a home and is comparing the costs of 30-year, fixed-rate mortgages. He needs a mortgage for $250,000.
One lender offers him a loan with an interest rate of 3 percent. Nico knows that percentage doesn’t reflect what the loan will really cost him, and the lender that offers the lowest APR is usually the cheapest, especially because he plans to stay in his home long term.
So, Nico looks at the fees the lender included in the APR:
- Origination fee (1% of loan principal): $2,500
- Discount points (1% of loan principal): $2,500
- Other closing costs: $900
These additional loan costs come to $5,900. Based on that, Nico uses Bankrate’s annual percentage rate calculator to determine the APR. (For an adjustable-rate mortgage, he would use this APR calculator for ARM loans).
He adds the additional loan costs to his loan total, and finds that even though the quoted interest rate is 3 percent, the APR, which includes the additional fees, is 3.183 percent.
There are different ways to calculate APR, so it’s best to clarify with your lender exactly which fees are in fact included in a quote. This helps you to know whether you’re making apples-to-apples comparisons between mortgage offers and gives you specific information you can use if you want to negotiate some of the fees before closing on the loan.