APR

A new homebuyer will quickly learn that there are many terms specific within the mortgage industry. One of the first terms that you will hear in reference to a mortgage is the annual percentage rate, commonly abbreviated to APR. This refers to the annual cost of the mortgage quantified as a percentage. The APR consists of all the costs of the mortgage. These include (but are not limited to) interest, closing costs, mortgage insurance, appraisal fees, and points the lender charges (if applicable). It is an inclusive list of all costs that are added to the principal of the loan, so the APR will always be a bit higher (usually 0.25% to 0.5%) than just the annual interest rate. Lenders are required to indicate the APR for every loan they offer. Understanding the APR will help new homebuyers shop around for a competitive rate.

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Understanding the APR

It is important to understand the total cost of a mortgage before committing to the loan. The APR provides a piece of the story but is not always inclusive of every cost. Here are some things to consider when shopping for the best mortgage:

  • The APR might not include every cost of the loan. For this reason, it is important to ask the lender for a GFE (Good Faith Estimate) that lists every line item cost of the loan.
  • When you have a fixed interest rate, you can expect to pay the same interest rate for the length of the loan. The APR rate is not fixed, it will fluctuate when if any of the variable factors of the loan change. Some of the variable factors are mortgage insurance and property taxes.
  • The loan with the lowest APR is not always the best option. This might seem counterintuitive, but consider this scenario:
    • Loan A has a lower APR than loan B.
    • Loan A has a higher interest rate and lower closing costs.
    • Loan B has a lower interest rate and higher closing costs.

Since closing costs are amortized over the entire course of the loan, you might end up paying more for the loan with a higher interest rate. Although it’s tempting to go for the loan with the lowest APR, you will want to review all of the costs to make sure it is truly the least expensive option.

Simply put, the APR is the total cost of borrowing money from a lender. By understanding the total costs included in the APR and by shopping around for the best financing, you can save a lot of money over the course of a 20- or 30-year mortgage.