All You Need to Know about APR on a Mortgage
When shopping for a mortgage, you’ll often encounter the term APR, which stands for “annual percentage rate.” Understanding APR is crucial before committing to a home loan, as it reveals the true cost of borrowing.
But what exactly is APR on a mortgage, and how can you determine whether it’s favorable? Here’s a breakdown of what APR means and how to calculate it.
What is the APR on a mortgage?
The APR, or Annual Percentage Rate, represents the true yearly cost of your mortgage. It encompasses not just the interest rate but also additional fees such as origination charges, mortgage points, and other closing costs. Because it includes these extra expenses, the APR provides a more comprehensive view of the total cost of borrowing compared to the interest rate alone. Understanding this number is crucial when comparing different lenders to ensure you get the best financial deal.
What’s Included in the APR?
Not all costs may be reflected in the APR, and calculation methods can vary between lenders. It’s important to ask lenders which fees are included in their APR calculation for your loan. Here are some common fees that may be part of the APR:
- Origination Fee: Covers the cost of creating and processing your home loan.
- Mortgage Points: Fees paid upfront to reduce your interest rate.
- Some Closing Costs: Various fees associated with finalizing a real estate transaction, which can be paid at closing or rolled into your loan.
- Private Mortgage Insurance (PMI): An additional cost if your down payment is less than 20 percent of the home’s value.
- Underwriting Fees: Charged for assessing your mortgage application.
- Escrow and Settlement Fees: Includes prepayments for insurance premiums and property taxes, held in an escrow account.
- Broker Fees: If you use a mortgage broker, you’ll need to pay these fees.
What is included in APR?
There are two primary types of APRs for mortgages:
- Fixed APR: Remains constant throughout the life of the loan. For instance, with a 30-year fixed-rate mortgage, your APR will remain the same for the entire term.
- Variable APR: Changes periodically after an introductory period, typically associated with adjustable-rate mortgages. As the base interest rate fluctuates, the APR adjusts accordingly.
Interest rate vs. APR – what’s the difference?
The interest rate is the percentage charged on the principal amount borrowed, not accounting for additional fees or charges. APR, on the other hand, includes these extra costs, such as mortgage insurance, closing costs, and loan origination fees. As a result, the APR is always higher than the interest rate and provides a clearer picture of the overall cost of the loan.
For example, Bank of America offers 30-year fixed-interest mortgages with an interest rate of 6.375% and an APR of 6.652%. Wells Fargo offers 30-year fixed-interest mortgages with an interest rate of 5.875% and an APR of 6.077%. Comparing these APRs rather than just the interest rates helps you evaluate the total cost more effectively.
Mortgage APR examples
Many lenders provide APR figures for their mortgage products, aiding in a more accurate comparison of loan offers. While some costs are fixed, others, like mortgage points, can be adjusted based on your preferences.
Once you select a lender, ask your loan officer to walk you through different APR scenarios to make an informed choice. This will help you understand how varying APRs might affect your overall loan costs.
How to calculate your APR
The good news is that you don’t need to do the math yourself—your mortgage lender will calculate the APR for you. However, if you want to verify the accuracy, you can calculate it on your own using these steps:
- Add Up Costs: Sum the total interest and fees you’ll pay over the life of the loan.
- Divide by Principal: Divide this total by the loan principal.
- Calculate Daily Cost: Divide that result by the number of days in the loan term.
- Annualize: Multiply the daily cost by 365 to annualize it.
- Convert to Percentage: Finally, multiply by 100 to convert the APR to a percentage.
For a simpler approach, you can use Bankrate’s mortgage APR calculator. Just enter your loan details, and the calculator will provide a full amortization or repayment schedule, either annually or monthly.
