If you’ve started looking into your mortgage options, you’ve probably encountered the terms “APR” and “interest rate” somewhere along the way. You might have even noticed that APRs are always slightly higher.
Why is this? And which one should you be looking at when shopping for your mortgage? Let’s break it down.
APRs and Interest Rates
Interest rates and APRs — or annual percentage rates — are both indicators of your loan’s cost. The main difference is what the two rates include.
The interest rate is what you’ll pay to borrow the funds. If it’s 5 percent, for example, you’ll pay 5 percent of the loan’s balance every year until the money is paid back in full. Interest rates can be fixed (meaning they stay the same the entire time you have the loan), or they can be adjustable (in which case, they will fluctuate up or down depending on the market).
An APR, on the other hand, is a broader measurement. It’s meant to indicate what you’ll pay for the loan in total every year — not just in interest. The APR includes your interest costs, as well as things like discount points, broker fees, closing costs, and other prepaid finance charges. This is why the APR is always higher than the posted interest rate.
There are also differences in how APRs and interest rates are determined. Lenders base the interest rates they offer on each individual borrower’s unique financial scenarios. Their credit score, income, debts, and other factors will all influence what rate the borrower is offered. Interest rates also depend on the current market’s prevailing rates.
APR is based on standard calculations. Aside from the interest component, the lender’s fees are going to stay the same. Their various origination fees and other expenses will remain consistent from loan to loan, regardless of the borrower’s specific credit or finances.
Which Should You Use When Mortgage Shopping?
Both numbers can help you compare your mortgage options when shopping around. To see what interest rate and APR a lender is offering you, fill out the lender’s application, and you’ll receive a loan estimate form. On page 1, you’ll see the interest rate under “Loan Terms,” and on page 3, you’ll see the APR under “comparisons.”
Consider using the interest rate you’re quoted to help gauge your monthly mortgage costs.
When comparing APRs, it’s important to get a break down of what’s included in a lender’s quoted rate. What fees are lumped into the APR? Most importantly, how much are those individual fees? You want to make sure you’re comparing apples to apples when looking at APRs and the costs included.
Another quick tip on APRs: If you’re choosing an adjustable-rate loan, the APR will not be an accurate depiction of your long-term costs. Since your interest rate will change on the adjustable loan, your annual APR may go up or down as well. On adjustable loans, your best bet is to assess the up-front interest rate, as well as any caps or maximums on future rate increases. This can help you gauge the potential long-term costs of your mortgage.
It’s important to have a good handle on your homeownership goals when comparing APRs and interest rates. For example, if you’re planning to stay in your new home for the long haul, finding the lowest-APR loan will save you the most over time. If you’re only going to stay a few years until you have kids or make a career move, you’ll want to focus more on the interest rate, as this will save you the most in up-front and short-term costs.
You can also calculate each loan’s break-even point — meaning the point at which you’ve saved enough money to pay for whatever your costs were. Use a mortgage point calculator to help pinpoint this number for your loan options, or talk to a loan officer for more specific guidance.
Whether you focus on the APR, the interest rate, or both numbers, the most important thing is that you’re informed. Ask each lender you consider for a loan estimate and request a full break down of what’s included in their quoted APR. After you’ve applied, you can ask for a full estimate of any closing costs or fees you’d be expected to pay, so you know exactly what you’d owe on closing day. (Make sure to include your down payment in that as well).
Get More Help
Need some help comparing your loan options? Just want to know what APRs and interest rates Embrace Home Loans can offer you? Reach out to a loan officer today for help. We’re here to guide the way.