Right now, mortgage interest rates are at historic lows—and people are lining up to take advantage by buying a home or refinancing an existing home loan.
But a lower mortgage rate doesn’t always equate to a better deal. In a hot market where transactions are unfolding quickly, you need to also consider the loan’s APR, which takes into account upfront fees and other costs, experts say.
For example, current 30-year refinance rates are around 2.9%. But at the same time, the average 30-year loan’s APR is about 3.1% because of the fees APR (or annual percentage rate) takes into account.
“The annual percentage rate is always confusing … it’s a broader measure of the cost of borrowing money than the interest rate,” says Linda Knowlton, president of the Florida Association of Mortgage Professionals. Your APR takes into account many of the fees you’ll pay to take out a mortgage, as well as the interest rate.
Mortgages are complicated, so putting in the time to understand them a bit better can help you find the right deal and save you thousands of dollars over the life of the loan. “Shopping around really does matter. It matters more in the short run than anything anyone can do to their borrower profile,” says Ralph Mclaughlin, chief economist at the California-based fintech startup Haus. A Haus study found a 0.75% rate difference between the cheapest and most expensive lenders, even when controlling for the other factors that influence mortgage rates.
Unfortunately, finding the best mortgage loan isn’t as simple as finding the lowest interest rate or APR. Both numbers are useful in different ways, you just need to understand what they are showing you. Because once you do, you’ll be able to more effectively apply them to your circumstances.
Here’s what you need to know about interest rates and APRs so you can understand how they apply to your specific circumstances. And once you understand these numbers, you’ll have a better understanding of the right questions to ask your lender when you’re shopping for a mortgage.
Mortgage Rates vs. APR
Mortgage rates and APRs are both expressed as a percentage, but they show different costs of the loan.
Home loans, whether for purchasing or refinancing, have upfront costs that should factor into your decision. These fees are not included in the loan’s interest rate, which is simply what you pay for borrowing the money. An APR takes the interest rate and fees into account.
“You can think of APR as an effective rate that you pay over the life of the loan, taking into account all the other fees that you have to pay when you take out a mortgage,” McLaughlin says.
Closing costs that are typically factored into your mortgage’s APR include fees such as:
Private mortgage insurance (PMI)
Loan processing fees
While lenders are required to disclose the APR, the fees you pay to get the loan can vary. “Those fees can differ from state to state, they can differ from lender to lender, and from broker to broker,” Knowlton says. This means that two mortgages can have the same interest rate but vastly different APRs.
The APR includes the fees charged by the lender for processing the loan, but it doesn’t factor in all of your closing costs. There are certains fees the borrower will pay regardless of what lender they choose, Knowlton says. These are typically costs associated with the property and aren’t included in the annual percentage rate calculation. APR also doesn’t factor in costs such as the appraisal, title insurance, or recording fees.
How to Use APR and Mortgage Rates to Find the Best Home Loan
A mortgage loan’s interest rate will impact your monthly payment, and a lower rate will get you a lower monthly payment and vice versa.
But your monthly payment isn’t the only cost associated with taking out a mortgage or refinancing a mortgage. You’ll also have to pay closing costs, which typically will cost thousands of dollars.
The APR will take into account many of these fees, but the APR is calculated based on the full loan repayment term. The problem is, you may not keep the loans for the full term.
“That’s the million-dollar question: how long do you think you’re going to be in a home?,” Knowlton says.
Homeowners who live in the 100 largest metro areas move after 6 to 18 years, according to a study by the National Association of Realtors. And with mortgage refinance rates nearly 2% lower than they were just two years ago, many homeowners are rushing to refinance. So there’s a good chance you won’t keep your mortgage for its full term, and that changes how useful APR is for determining the cost of your loan.
When you’re shopping for a mortgage, you shouldn’t just rely on APR because it doesn’t take into account how long you may keep the loan.
Take this example of 30-year mortgages where each has an initial loan balance of $250,000.
When two loans have the same interest rate, APR can be an easy way to see which mortgage has higher fees, as you see with loans A and B. But when the interest rate is different, you may need to look beyond APR.
Loan A has a higher interest rate and a higher APR than loan C. You might assume that makes loan A more expensive, but that’s not necessarily the case. Up until year four, loan A is actually cheaper than loan C. So if you refinance your mortgage or sell your home within the first four years, loan A would end up being the best deal.
Looking at a loan’s interest rate or APR can help you analyze different mortgages. But you can’t stop there because there are factors that those numbers don’t take into consideration. So it’s important to look carefully at each Loan Estimate you receive to accurately compare the cost. And to understand how each type of mortgage or refinance loan applies to your circumstances.
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