Mortgage Rates And APR : Finding Low Rates And “Great Deals”

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It's a myth that you can shop for a mortgages using Annual Percentage Rate (APR) calculations. You can't shop for loans by APR. Period.

No matter what your loan type --  FHA, conventional loans, VA, USDA or jumbo -- shopping by APR makes it less likely that you'll choose "the best deal". APR is among the most easily manipulated numbers in the mortgage business and some lenders count on you not knowing that.

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What Is "APR"?

More commonly called APR, Annual Percentage Rate is a government-concocted math formula. It's meant to measure the "true cost" of a loan, from the date of closing to the date of payoff.

APR is roughly measured by taking the original loan size, accounting for closing costs and prepaid items, then estimating how much will have to be paid over 30 years to pay off the loan in full.

APR answers the question, "If I borrow this much money, and it costs me this much to pay off my loan, what would my theoretical mortgage rate have been?"

APR is printed in the top-left corner of the Federal Truth-In-Lending Disclosure, as shown above.

Loan officers are required to disclose a mortgage's particular APR every time they make a rate quote. This is federal law, meant for consumer protection. By showing APR along with every rate quote, it's believed that customers will be better informed and can make better loan choices.

In some cases, this is true. In many cases, it is not.

APR is not the "apples-to-apples" comparison tool it's advertised to be. This is because the loan with the lowest APR isn't always the loan that's best for you.

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APR Can't Be Your "Apples-To-Apples" Tool

Banks and lenders love to promote their "low APR loans" -- especially online. In fact, most mortgage marketplaces sort loans by APR by default. This means that the loans with the lowest APR will show up first on your list of approved mortgage lenders.

Unfortunately, getting a low APR doesn't translate to getting a "good deal". This is because the APR formula is flawed.

Calculating for APR requires a lender to makes serious assumptions about the future and, as we all know, predicting the future is impossible.

For example, here are three egregious assumptions that the APR formula makes about your loan:

1. The APR formula assumes that you will hold your loan for 30 years
2. The APR formula assumes that you will never make extra principal payments of even $1
3. The APR formula assumes that you will not refinance or sell your home

If any of these statements are "untrue", or have the chance of being untrue, APR fails as a comparison tool.  This is a huge deal when comparing loans with discount points to loans without discount points, and it's one way in which online lenders make their "deals" look great online.

For example, as compared to a loan with no discount points, a loan with discount points will have higher closing costs but lower principal + interest payments each month. Over the life of the loan, the lower payments will render the loan with discount points "cheaper" and so it will have a lower APR than the low-fee mortgage choice.

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If you chose your loan strictly by APR, you would end up choosing the loan with the highest closing costs and the best long-term payoff.

This is fine if you plan to stay in your home for 30 years and never make extra payments on your loan. If you plan to sell in fewer than that, though, the APR comparison becomes worthless. In this case, buying by APR is the worst way to shop -- you'll front-load your mortgage with fees.

More Ways In Which APR Is Flawed

Your loan's APR can be affected by other assumptions, too.

First, as we discussed, mortgage loan costs are added to the APR formula but, at the start of a loan, third-party loan costs such as appraisal and title services are sometimes unknown. As a result, your bank may inadvertently understate those fees. When they do, it makes APR appear artificially low.

With estimated fees, in other words, comes an estimated APR.

And, second, on adjustable-rate mortgages, the APR formula make assumptions about how the loan will adjust during its complete, 30-year term. Will mortgage rates rise over 30 years? Will they fall? By how much will they rise or fall?

Two lenders using two different set of assumptions will publish two different APRs -- even if the loans are identical in every other way. The lender whose mortgage rate adjustments are most aggressively-low will present the lowest APR.

This, too, can misdirect a consumer.

Look At Rate-And-Costs When Choosing A Loan

The important thing to remember is that APR is not the metric for comparing mortgages -- it's merely a metric. The better way to compare two mortgage rate offers is to look at the mortgage rates as compared to the fees. APR should have nothing to do with it.

If you're shopping for a mortgage by APR, stop now. Start with a fresh quote for a mortgage rate -- that's the rate at which you're borrowing anyway. Get a rate quote without fee or obligation and shop for rates the right way.

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