In this post we explore the difference between APR and Interest rates and how it might affect you as a borrower?
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A home loan's interest rate is expressed as a percentage of the principal loan amount that a mortgage lender charges you on an annual basis for borrowing your principal loan amount.
This rate doesn't include fees or closing costs and is only based on the amount you borrow for your home loan.
APR
An APR is a home loan's Annual Percentage Rate. Much like the interest rate, APR is also displayed as a percentage, but it is typically higher than the accompanying interest rate. This is because an APR not only takes your interest rate into account, but also factors in other costs, such as most closing costs and lender fees. The APR provides a more holistic view of your total mortgage cost on an annual basis.
How closing costs and interest rate affect APR?
As a general rule of thumb, interest rates and APRs have an inverse relationship. A low closing cost or “no-closing-cost” loan with higher interest rate will lead to a lower APR. However, when paying loan closing costs, including paying points for lower interest rates leads to a higher APR.
Are you getting a good deal?
While some lenders may advertise a no-closing-cost loan, it's important to understand that those costs are still there, but instead of paying them upfront, they're “absorbed” into the loan.
A common way to do this is by adjusting the opposing levers on interest rates and APR. In other words, in exchange for a higher interest rate, you may be able to lower your upfront closing costs and your total APR. Don't be fooled. APRs and Interest Rates can be manipulated. Loan estimates and fee worksheets cannot.
So, how do you know if you're getting a good deal?
To know whether you're getting a good deal or not, and to determine the lender's cost of the loan, or in other words your closing costs, focus on the lender's fees, not the rate.
We hope this helps give you a good stepping off point to your questions about Interest Rate and APR. If you have any more questions about this, or anything else mortgage related, don't hesitate to reach out.
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Be sure to ask us for a free quote on your next mortgage. We'll personally work with you and help you through the whole process.
Broaden your mortgage expertise by reading about payment timing and understanding PMI costs. Discover the mechanics of amortization and explore what triggers lead generation. You can also get insights into closing costs and examine cases where mortgage payoff exceeds balance.
Mortgage Brothers LLC does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Mortgage Brothers NMLS 1007154, NMLS #210917 and 1618695. Equal Housing Opportunity.
Transcript of the Mortgage Brothers Podcast
How Does a Mortgage APR Work and What Does It Mean?
Eddie Knoell and Tom Knoell — Mortgage Brothers Podcast
Eddie Knoell: I'm Eddie Knoell.
Tom Knoell: And I'm Tom Knoell. Welcome, everyone! This is the Mortgage Brothers Podcast Show.
What Is APR? [00:02]
Eddie: Today, we're answering a common question: What is APR, and how does it work for mortgages?
Tom: APR, or Annual Percentage Rate, is a term you often hear, especially in car commercials. But when it comes to mortgages, many borrowers get confused about how it differs from the interest rate.
Eddie: Borrowers who ask about APR are usually doing their research—they've read somewhere that they need to pay attention to it. But understanding what APR actually means is just as important.
Why Does APR Exist? [02:27]
Tom: APR was created as a way to help consumers compare loan costs between lenders. The idea is that it provides an “all-in” number that includes both the interest rate and certain loan fees.
Eddie: In theory, APR allows borrowers to compare apples to apples when evaluating different mortgage offers. But in practice, it can be misleading.
Understanding the Interest Rate vs. APR [03:37]
Eddie: Your interest rate is simply the percentage charged on your loan balance annually. It stays the same throughout the life of the loan.
Tom: APR, on the other hand, includes both the interest rate and certain loan-related costs. This means that APR will almost always be slightly higher than the interest rate.
Eddie: Think of it this way:
- Interest Rate = Cost of borrowing the money
- APR = Interest rate + certain fees included in the loan
Why APR Can Be Misleading [05:27]
Tom: The problem with APR is that not all lenders include the same fees in their calculations. While regulations exist, we've seen variations in how different lenders calculate APR.
Eddie: This means that two loans with the same APR might actually have different total costs, depending on what each lender includes in the calculation.
Tom: That's why it's important to not rely on APR alone when comparing loans.
How Closing Costs Affect APR [06:34]
Eddie: In general, APR increases when loan costs are higher.
- If a loan has zero closing costs, the APR and interest rate should be the same.
- If a loan includes points or other fees, the APR will be higher than the interest rate.
Tom: This is why two lenders offering the same interest rate might show different APRs—one might be including more fees in the calculation.
The Best Way to Compare Loans [08:15]
Eddie: The best way to ensure you're getting the best deal is to ask each lender for:
- The exact interest rate they're offering.
- The total, total closing costs (everything included).
Tom: I say “total, total” because some lenders try to leave out certain costs when quoting fees. If you compare rates this way, you won't need to rely on APR alone.
Example Loan Comparison [09:19]
Let's look at two example loans:
Loan A:
- Interest Rate: 3.25%
- Closing Costs: $0
- APR: 3.25% (since there are no fees)
Loan B:
- Interest Rate: 2.875%
- Closing Costs: $3,750
- APR: 2.973% (higher because it includes the loan costs)
Eddie: Even though Loan B has a lower interest rate, the APR is higher due to the added costs.
Final Thoughts on APR [10:59]
Tom: APR is a helpful tool, but it can be manipulated or calculated differently by lenders.
Eddie: The key takeaway is: Focus on total loan costs, not just APR.
Tom: And remember, APR mainly accounts for loan costs, not prepaids like taxes and insurance, which can also impact your total costs.
What Should You Do? [12:39]
- Compare lenders by asking for the exact interest rate and total closing costs.
- Be cautious when using APR as the sole factor in decision-making.
- If you have questions, ask your lender to break down what's included in the APR calculation.
Eddie: Hopefully, this gives you a clearer understanding of how APR works. If you have questions about buying or refinancing, reach out to us!
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Disclaimer: This content is for informational purposes only. Please consult legal or financial professionals before making any decisions.