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Posted 10/18/2016

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What Is APR? Your Quick Guide To Getting The Best Mortgage Rate

APR Shopping For A Mortgage

Annual Percent Rate Helps You Shop For Loans

When mortgage lenders advertise an interest rate, they are legally required to also disclose the loan’s APR, or Annual Percentage Rate.

It tells you the whole cost of borrowing -- the interest plus loan fees and points -- and it's supposed to make it easier for consumers to compare mortgage offers.

However, there’s a lot of confusion about what APR really means, and how to use it to get the best mortgage rate when you shop for a home loan.

This guide explains Annual Percentage Rate, its limitations, and how to use it (or NOT use it) to shop for a mortgage.

Click to see today's rates (Apr 24th, 2017)

Why Is It Necessary?

Annual Percentage Rate tells you how the loan's fees affects its total cost. If you borrow $100,000 at 3.25 percent, your payment would be $435. However, if the loan costs you $5,500, you're making the payment for a $100,000 mortgage, but only actually getting $94,500 ($100,000 - $5,500).

In reality, then, you'd be paying more than 3.25 percent when you borrow.

One reason it’s important to look at a loan’s Annual Percentage Rate is that some lenders advertise very low rates to get you to click on their ads and work with them. However, if you see a mortgage offer with a very, very low interest rate, check its APR.

When the APR is significantly higher than the advertised interest rate, chances are it comes with expensive upfront costs, and it might not be the best deal for you.

How Does APR Help You Shop For A Mortgage?

Annual Percentage Rate is another way of showing the cost of your mortgage – its interest plus its fees -- to make comparing loans with different rates and pricing easier.

Suppose you’re considering three $100,000 loans – Loan A has an interest rate of 3.25 percent and $5,500 in loan costs, while Loan B has $1,000 in charges and an interest rate of 3.5 percent. Loan C has a 3.75 percent rate and zero costs. Which is better?

  • Loan A’s payment is $435.21 and its APR is 3.68 percent
  • Loan B’s payment is $449.04 and its APR is 3.58 percent
  • Loan C’s payment is $463.12 and its APR is 3.75 percent

Loan C has no costs, so its APR equals its interest rate. Loan B’s lower fees make it cheaper than Loan A over the life of the loan, even though its payment is higher.

Is The APR Always Higher Than The Advertised Rate?

The APR can be equal to or lower than the advertised rate.

So-called “no-cost” loans have APRs equal to their advertised interest rates.

If you have a loan in which the lender pays you a rebate for accepting a higher interest rate, your Annual Percentage Rate for that loan may be lower than the advertised interest rate. This may also be the case for certain adjustable rate mortgages (ARMs) with introductory fixed-rate periods.

Click to see today's rates (Apr 24th, 2017)

Is The Loan With The Lowest APR Always The Better Deal?

No! Too many articles tell borrowers to just choose the loan with the lowest APR, but it’s not that simple. When the loan with the lowest APR also has the lowest upfront costs, it does represent the best deal.

But when the loan with the lower APR comes with higher upfront costs, the math can change if you repay your loan early. That's because your upfront costs stay the same, but they are spread over fewer months.

Here's what happens to the examples above if you sell or refinance in five years instead of 30:

  • Loan C’s APR remains at 3.75 percent because it has no fees
  • Loan B’s APR increases to 3.91 percent
  • Loan A’s APR jumps to 5.44 percent because of its high upfront costs

In general, if you expect to have your loan for only a few years, the loan with lower upfront costs is less risky.

Shortcomings of Annual Percentage Rate

APR cannot be reliably used for every loan shopping situation. Here are limitations to be aware of:

  • The loans being compared must be essentially the same
  • APR disclosures assume borrowers keep the loans for their entire terms
  • APR disclosures can vary between lenders who include different fees in the calculation
  • Adjustable rate loan APRs involve a lot of guesswork

The APR for ARM loans assume that the interest rate does not change during the loan’s introductory period (five years in the case of a 5/1 ARM); it takes for granted that when it begins adjusting, the new rate will be based on current financial indexes, not future ones.

No one can predict the future.

ARM APRs are slightly useful for comparing similar ARM loans to each other, but the actual APR over the life of your loan will almost certainly be different.

How To Shop

Follow these rules when using Annual Percentage Rate to shop for a home loan:

  • A loan with the lowest APR and the lowest upfront costs is your best deal
  • If you keep your loan for its entire term, the loan with the lowest APR is cheapest, even if its upfront costs are higher
  • Compare APRs only between loans of the same type
  • If two loans with different pricing have similar APRs, choose the one with lower upfront costs
  • Avoid dealing with APR by choosing the company with the lowest charges for a certain rate
  • Bypass APR decisions by choosing the company that offers the lowest rate for a certain cost

However you choose to shop for your mortgage, the important thing is that you do shop. Compare quotes from several competing lenders before you commit to a mortgage.

What Are Today's Rates?

Mortgage rates are low, and home buyers and refinancing households are finding near-record low APRs.

Check today's rates and get a quote from at least three sources to get your best mortgage value.

Click to see today's rates (Apr 24th, 2017)

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.

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