- Posted by Jordan Blakley
Understanding the real cost of a mortgage can be dizzying! So many different costs arise at various stages of the complicated loan process, it can be tough to determine how much you are actually paying for a loan. Then, if you want to compare loan offers, the differences among lenders' loan programs can make it even more difficult to make apples-to-apples comparisons.
To make comparison easier for borrowers, the federal Truth-in-Lending Act requires lenders to post the annual percentage rate (APR). This calculation enables borrowers to have a clearer picture of all costs associated with a particular loan. And, it simplifies mortgage comparison shopping – bringing prospective homeowners closer to the best deal possible!
So, to help you with your comparison shopping, here are a few APR details to remember:
What is APR – A Quick Overview
The APR is the true interest rate you'll pay over the full term of the loan. Quite often, people confuse the APR for the interest rate of the loan, but they are NOT the same thing. The APR is almost always different from the interest rate for which the borrower applied. Remember, a loan's interest rate is used as the basis for monthly mortgage payments and does not consider other loan charges, such as loan discount points, lender fees, and any mortgage insurance premiums, among other prepaid finance charges at closing. The APR, however, DOES take into account these charges in addition to a loan's interest rate.
Where Do I Find the APR?
A loan's APR can always be found in the top, left corner of your Truth-in-Lending disclosure form. In addition, the government also requires that all mortgage companies disclose their APR when they advertise a new rate.
Advantages of APR
The main advantage of APR is that it allows an apples-to-apples comparison between loan products and institutions. Generally speaking, the lower the APR, the lower the total cost of the loan.
For example, here are three actual lenders and their advertised rates for a 30-year fixed rate mortgage on October 13, 2012:
|30-Year Fixed||Interest Rate||Points & Fees||APR|
So, even though Lender A has the lowest interest rate advertised, points, fees, and other prepaid finance charges actually make it truly more expensive than Lender C, who is advertising a higher interest rate, but points and fees that are only 45% the amount Lender A charges.
In this sense, the APR can help a borrower determine which loan will be the least expensive, long-term.
The APR also can reveal potential surprises on adjustable rate loans. You might receive a quote for 2.625% on a 7-year adjustable rate mortgage (ARM), but the APR could be 3.209% because government rules on APR require that the lender use the highest potential interest rate of 3.25% for years 8 through 30 in the calculation.
Shortcomings of APR
The APR is supposed to measure the true cost of a loan, but, it is not without its shortcomings.
First, not all lenders calculate APRs similarly. Fees included within the APR often vary from one lender to the next. And this, by definition, cancels out one of APR's greatest assets – a straightforward, apples-to-apples comparison.
So, before you commit to any lender, make sure you ask what fees are included in the APR calculations. And remember, a loan with a lower APR may not always guarantee the best rate.
Second, it's important to recall that the APR represents the total cost of borrowing over the "life of the loan." In this definition, the "life of the loan" is believed to be full-term. So, if homeowners move, pay off their mortgages early, or choose to refinance mid-term, like most homeowners do, the APR comparison will be less valuable.
Last, the interest rate for an ARM can change, therefore you cannot directly compare APRs on ARMs to APRs for fixed-rate mortgages.
The APR – So, How Useful Is It?
The APR is a great starting point for those beginning to compare loans. But, the APR is just one of many tools used to compare mortgages. And, since not all lenders calculate APRs similarly, it is important that homeowners review all loan terms together. Compare loan offers by obtaining a Good Faith Estimate (GFE) from each lender. The GFE is a government-required document that gives you an estimate of the settlement charges and loan terms if you're approved for the loan.