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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 is an important concept to understand before you commit to a home loan.
So, what does APR mean on a mortgage? Here’s what you need to know.
What is the APR on a mortgage?
APR stands for the annual percentage rate. This term indicates the cost of your loan each year.
When referring to the rate on a mortgage, it’s easy to confuse the APR and the interest rate, but they aren’t the same thing. The APR reflects the interest rate and all other fees, such as an origination fee and mortgage points. For the most accurate comparison between two mortgage offers, the APR will give you a much better idea of how much each offer will cost overall than just the interest rate.
“The APR helps the borrower evaluate the true all-in cost of their mortgage,” says Nilay Gandhi, senior wealth advisor with Vanguard Personal Advisor Services in Philadelphia.
To give you that all-in cost, some of the fees the APR might factor in include:
- Origination fee: This fee covers the cost to process and fund your home loan.
- Mortgage points: You can purchase points from your lender to lower your interest rate.
- Some closing costs: These costs, which you can pay at closing or roll into your loan, cover a variety of services necessary to start and finalize a real estate transaction.
- Private mortgage insurance: If you put down less than 20 percent on your home, you’ll have to pay for this insurance.
- Underwriting fees: During underwriting, your lender assesses whether you’ll be approved for a mortgage, and these fees cover this service.
- Escrow and settlement fees: You may need to pay a few months’ worth of insurance premiums and property taxes at closing, which will be held in a mortgage escrow account.
- Broker fees: You’ll need to pay these fees if you use a mortgage broker.
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,” says Gandhi.
How does APR work?
Lenders calculate your APR not just based on the current interest rate environment and the fees they charge but also with you in mind. The stronger your financial profile — like having a strong credit score and a low debt-to-income ratio — the lower your APR will be.
An APR should give you a good idea of the loan’s overall cost, so it’s a good comparison tool to use when shopping for lenders and the best deal. But because fees included in the APR can vary by lender, you’ll need to read each loan offer closely to see what’s included.
How to calculate your APR
Good news: You don’t have to do the math here. The mortgage lender calculates the APR for you. If you want to double check the lender’s work, you can calculate the APR yourself by following these steps:
- Add up the interest and fees you’ll pay over the loan term.
- Divide that number by your loan principal.
- Divide that figure by the number of days in the loan term.
- Multiply that answer by 365.
- Finally, multiply that number by 100 to convert the APR to a percentage.
Or, if you want to do things with less pencil pushing, you can use Bankrate’s mortgage APR calculator. Once you input the loan information, you’ll receive a full amortization, or repayment, schedule, either by year or by month.
APR mortgage examples
Many lenders advertise the APR for their loan products, which can help you more accurately compare mortgage offers and costs.
Once you find a mortgage lender, have your loan officer walk you through different APR scenarios so you can make an informed decision. For example:
|APR with fee and no points||APR with fee and 1 point||APR with fee and 2 points|
|Loan term||30 years||30 years||30 years|
|Origination fee (1% of amount borrowed)||$3,100||$3,100||$3,100|
|Points (1% of amount borrowed)||$0||$3,100||$6,200|
Different types of APRs
When it comes to mortgages, there are two main types of APRs you should know:
- Fixed APRs: If you choose a fixed-rate mortgage, you’ll get a fixed APR. That means the APR stays the same for the entire life of your loan. If you get a 30-year fixed mortgage, for example, you’ll have that same APR for all 30 years.
- Variable APRs: As the name suggests, variable APRs change after a set introductory period. This applies if you get an adjustable-rate mortgage. As the base interest rate on your loan changes, the APR adjusts accordingly.
Frequently asked questions on APRs
The main difference between the interest rate and the APR is that the interest rate is just one part of the APR. The interest rate only tells you how much you’ll pay in interest, while the APR tells you the total loan cost per year, including origination costs and any other fees, expressed as a percentage.
The mortgage market changes on a daily basis, so a “good” APR one day might not be so good the next. Currently, mortgage rates have been fluctuating, so if you’re ready to buy a home and a lender offers you a rate you like, ask for a rate lock.
Keep an eye on rates so you understand longer-term trends and what’s considered a fair rate. Bankrate’s mortgage rate tables can help.
Bottom line on APRs
When you’re applying for a mortgage, lenders consider a variety of factors, including your credit score, employment, income, debt, assets and down payment, to help them determine what interest rate to offer you. They then combine that with the fees they charge to determine the APR for your loan.
To get the best rate, shop around and compare APRs from at least three mortgage lenders.