What is the 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, but they aren’t the same thing. The APR reflects the interest rate and all other fees, such as an origination fee and points. For the most accurate comparison between two mortgage offers, the APR will give you a much better idea than the interest rate of how much each will cost overall.
“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.
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.
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 by inputting the loan information and receive a full amortization, or repayment, schedule, either by year or by month.
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|
What’s a ‘good’ APR on a mortgage?
The mortgage market changes on a daily basis, so a “good” APR one day might not be so good the next. Currently, mortgage rates are increasing, so if you’re ready to buy a home, now might be the best time to lock in your rate.
Keep an eye on rates so you understand how they fluctuate, longer-term trends and what’s considered a fair rate. Bankrate’s mortgage rate tables can help.
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.
To get the best rate, shop around.
“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,” says Gandhi.
If you can handle a higher monthly mortgage payment, consider 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),” says Gandhi. “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.”