What is APR on a mortgage and how does it work?

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When you’re buying a house, sometimes it can feel like mortgage lenders and brokers are speaking a different language. If you’re shopping for a mortgage, you’ll likely come across the term APR, which stands for annual percentage rate, an important concept to understand before you commit to a home loan. Here’s what you need to know.

What is the APR on a mortgage?

When referring to the rate on a mortgage, it’s easy to confuse the APR and the interest rate.

“The APR — annual percentage rate — on a mortgage reflects the interest rate, but also includes additional mortgage fees that are paid upfront, such as origination fees, broker fees and points,” explains Nilay Gandhi, senior financial advisor with Vanguard Personal Advisor Services in Philadelphia.

“The APR helps the borrower evaluate the true all-in cost of their mortgage,” Gandhi says.

Because the APR factors in costs beyond just the interest rate, it’s smart to pay attention to every expense to get the best overall rate for your mortgage. Small changes in the APR can have a big impact on the total amount you’ll pay for your home over time.

To sum it up, “the higher the APR, the more you’ll pay, everything else being equal,” Gandhi says.

APR examples

Many lenders advertise the APR for their loan products, which can help you more accurately compare mortgage offers and costs. You can also calculate the APR with Bankrate’s APR calculator, where you can input the loan information and receive a full amortization schedule, either by year or by month.

Once you find a mortgage lender, consider having them walk you through different APR scenarios so you can make an informed decision. Here are two example comparisons.

Amount borrowed $250,000 $250,000
Interest rate 3.5% 4%
Loan term 30 years 30 years
Fees (1% origination plus 1 point) $5,000 $5,000
APR 3.66% 4.165%
Monthly payment $1,122.61 $1,193.54
Loan payments total $404,141 ($409,141 with $5,000 fees) $429,673 ($434,673 with $5,000 fees)

What’s a ‘good’ APR on a mortgage?

The mortgage market changes on an almost daily basis, so it’s smart to keep an eye on mortgage rates so you can understand how they fluctuate and also learn about longer-term trends and what’s considered a fair rate. Bankrate’s mortgage rate table can help in your research.

“In general, borrowers today can expect an APR in the neighborhood of 2.5 percent to 3.5 percent, depending on the length of their loans and the strength of their borrowing credentials,” Gandhi says.

Bottom line

When you’re applying for a mortgage, lenders will consider a variety of factors, including your credit score, employment, assets and down payment, to help them determine what interest rate to offer you.

To get the best rate, Gandhi recommends prospective homebuyers hop around to compare rates and fees.

“Credit unions, for example, are a great place to start, as they often have lower fees in comparison to banks, which can result in a lower APR,” Gandhi says.

If you can handle a higher monthly mortgage payment, Gandhi also suggests considering a shorter loan term, such as 15 years instead of 30, which will cost you less in the long run.

However, make sure your monthly mortgage payment fits comfortably within your budget. One way to keep it manageable is to make a 20 percent down payment. That keeps you from having to pay private mortgage insurance, or PMI, which adds to your monthly costs.

“I always encourage clients to pay attention to the all-in cost, which is often referred to as PITI (principal, interest, taxes and insurance),” Gandhi says. “Too often, individuals focus on their rate or just the principal and interest, but it’s important to focus on the total cost to ensure you can afford the payments.” 

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