What Is the Annual Percentage Rate on a Mortgage Loan?
Should you use the annual percentage rate, or APR, to compare loan offers? It’s one strategy to consider. Before you can decide if it’s a good choice for you, you’ll need to know what an APR is, how it compares to an interest rate, and the problems with using it to compare home loans.
Defining the APR on a Home Loan
What is the annual percentage rate on a mortgage loan? As Investopedia explains, it’s the theoretical cost of borrowing money. It’s expressed as a percentage and calculated to be the annual cost of your loan. It includes the interest rate and various fees. The Truth in Lending Act requires lenders to disclose this information to borrowers. However, informed consumers will recognize that there is a fair amount of leeway in the calculation process.
Comparing Interest Rates and APRs
What is the difference between an interest rate and an APR? The Consumer Financial Protection Bureau offers an explanation:
- An interest rate is the cost you pay to a lender to borrow money. It’s expressed as a percentage.
- An APR is a more comprehensive measure of the cost of borrowing. Also expressed as a percentage, it includes the interest rate, fees, points, and other charges.
Exploring the Benefits of Using APR to Compare Mortgage Loans
As NerdWallet indicates, looking at APRs can be helpful when you want to compare home loans that have different interest rates, discount points, and fees. Looking at APRs also makes it easier to see when a lender is using a low interest rate to lure customers in, but they’re making up the difference with high fees. When contemplating APRs as you evaluate loan offers, make sure not to mix interest rates and APRs. While the two figures may look alike, comparing them is like comparing apples and oranges.
Recognizing the Problems with Using APR to Compare Mortgage Loans
An APR can be a great tool for comparing different loan offers, but it isn’t perfect. As WalletHub points out, there are some issues:
- There’s a lack of standardization regarding the included fees. When calculating the APR, some lenders use the interest rate and five fees. Others might include the interest rate and ten fees. That level of variation means that borrowers still need to ask lenders questions and review the fine print carefully to determine if a loan is a good deal.
- Many borrowers don’t keep loans for the entire term. APRs are calculated as if you’ll keep the loan for the entire contract. The majority of borrowers today will sell or refinance before that point, so the data isn’t necessarily as authentic as it seems.
- Borrowers need to take into account the kind of loan it is when weighing APRs. If you’re comparing loans of the same kind, a comparison of APRs may be useful. However, if you’re considering different types of home loans, then you need to know whether or not it’s fair to consider APRs. For example, APRs on fixed-rate loans are fairly accurate because these loans have a stable interest rate. In contrast, APR is less helpful when weighing adjustable-rate loans because the interest rate will shift with the market, and those shifts are hard to predict. In a similar fashion, using APR to compare loans that have mortgage insurance with loans that don’t is unlikely to be helpful because the mortgage insurance will push up the APR.
While it may not be the only thing you want to consider, the APR is certainly a useful factor to weigh when trying to compare home loan offers. If you’re searching for the right home loan for your needs, reach out to the home loan experts at PrimeLending West Texas today.