What is a Mortgage APR? How Is it Different from the Interest Rate?
Do you plan to shop for a mortgage loan soon? If so, you'll eventually be presented with both a mortgage APR and a regular interest rate. Both of these numbers can be used to compare one offer to another, and to spot the best deal. But they are two different things.
This article answers two common questions among first-time home buyers:
- What is the definition of a mortgage APR?
- What is the difference between the APR and the interest rate?
What is a Mortgage APR?
APR stands for annual percentage rate. All loans and credit cards have APRs associated with them. They are designed to give consumers an easier way to compare one offer or product to another. So they can be useful during the shopping and comparison process. They typically include the interest rate plus other lending fees, presented as an annualized percentage rate.
Definition: The mortgage APR is the annual rate charged on a home loan, expressed as a single percentage. The APR shows you the full cost of financing, because it includes the mortgage interest rate plus other fees or costs applied to the loan.
APR Versus Mortgage Rate: What's the Difference?
Now you know what an APR is. Let's move on to question #2. What is the difference between the APR and the standard mortgage rate?
When you take out a home loan to buy a house, the lender will tack on various fees and charges. These additional costs can increase the size of your monthly payments. So you obviously need to know about them in advance. After all, you can't compare one mortgage offer to another until you know the full cost of the loan.
That's where the annual percentage rate comes in. The mortgage APR gives you a more complete picture of the annual cost of the loan, which allows you to more accurately compare one product to another.
Lender 'A' might offer you a lower interest rate than Lender 'B,' but that doesn't automatically make it the best offer. You still have to account for those additional fees mentioned above. If Lender 'A' offers you a slightly lower rate but charges you significantly more in fees, you end up paying more -- even though the mortgage rate was lower.
If you compared the two loan offers based on the mortgage rate alone, you would think Lender 'A' was offering you the best deal. But if you looked at the mortgage APR for each loan, you would see that this was not true at all.
That's why the annual percentage rate is so important to borrowers who are shopping for a home loan. It allows you to compare one offer to another based on the true cost of financing. It helps you compare apples to apples.
The APR for a home loan typically includes the following:
- Points and prepaid interest
- Origination fees
- Attorney and notary fees
- Document preparation fees
- Private mortgage insurance
According to David Newton, an economics professor at Westmont College: "[The APR] is the one common denominator by which you can compare loans side by side, comparing apples to apples to apples."
By Law, Lenders Must Disclose It to You
Lenders are required by law to show you not just the standard mortgage rate for your loan, but the APR as well.
See for yourself. Do a Google search for "Wells Fargo mortgage rates" and take a look at their current advertised offers. You'll find the standard interest rates listed in one column, and the APRs listed in another column. This will be true for all of their loan products and categories (30-year fixed, 15-year fixed, 5-year ARM, etc.).
For instance, at the time this article was published, Wells Fargo was advertising mortgage rates of 4.500% in the 30-year fixed category. The advertised APR for the 30-year loan was 4.673%. The second number will always be higher because it also includes fees, points and mortgage insurance (when applicable), on top of the interest charges.
This is the primary difference between the interest rate and the mortgage APR. Thus, it's the key takeaway from this lesson. The interest rate is the baseline amount you pay to borrow money from the lender. But it's not the only cost. The mortgage APR is the total finance charge on the loan, including the additional costs imposed by the lender.
As a borrower, you should also weigh the pros and cons of paying points at closing. Points are a form of prepaid interest. You pay them up front to secure a lower rate on your mortgage loan. This could greatly reduce the amount of interest you pay over the life of the loan. But it's an upfront cost you must pay out of pocket. So there's a clear tradeoff to consider (upfront expense versus long-term savings).
Disclaimer: This article answers the frequently asked question, What is a mortgage APR? This is a high-level tutorial that covers the basic differences between annual percentage rates and "regular" interest rates assigned to home loans. Despite the length of this tutorial, we have only scratched the surface of this particular subject. We encourage you to continue your research beyond our website, until you have a full understanding of mortgage APRs, fees, points, and other concepts relating to mortgage financing.