If you’re thinking about buying a home and you’ve started shopping around for mortgage rates, you’ve probably come across the term “APR.” What does it mean?
The simple answer is “annual percentage rate,” which is what borrowers use to compare different mortgage products. But that begs other questions. For example, what goes into calculating the APR? And are all APRs the same?
So, let’s get into it.
Why APR Exists
In a nutshell, the APR of a mortgage loan is the annual rate of interest on the amount of money being borrowed in addition to any additional fees, such as closing costs, mortgage insurance, or origination fees. Thanks to the Truth in Lending Act (TILA), lenders are required to disclose the APR on a mortgage before the borrower applies for a loan, so consumers truly understand what they are paying for. The idea behind APR is to give consumers a consistent, accurate way to compare rates between lenders.
Under TILA, lenders can’t mislead customers about the rates they’ll actually pay and must disclose the APRs of their various mortgage products. Without such safeguards, lenders could potentially mislead borrowers by advertising much lower rates that do not represent what borrowers actually pay. This is important, because even small increase or decrease in the rate can equal tens of thousands of dollars over an entire 30-year loan term.
How APR is Calculated
APRs are meant to give borrowers apples-to-apples comparisons of loan products. For lenders, there is clear guidance about which fees are included in the APR and which fees are not, so all lenders should calculate APR the same.
For example, the APR will include an application fee, loan processing fees, an escrow fee, tax transcripts, and wire fees, but it does not include property taxes or an appraisal fee. However, the APR will include any appraisal administration fees.
Other factors that go into the APR you are offered on a loan are your credit score, your debt-to-income ratio (DTI), and the loan-to-value ratio (LTV) of the loan—that is, the amount of money you’re borrowing compared to the value of the home you’re buying. Typically, borrowers with excellent credit and lower DTI ratios are offered lower a lower APR. The same applies for loans with low LTVs.
Obviously, one way to make sure you are offered the lowest APR possible is to improve your credit score by making sure you pay your debts on time, or even lowering your overall obligations by paying off credit cards and other loans, if possible. It’s also important to know that interest rates change all of the time, even daily. That’s why it’s usually smart to lock in a rate as soon as you’re sure you want to move forward with your loan.
What You Need to Know
To truly compare the APR offered by one lender with another lender, you’ll need to find out how much you are being charged for certain fees. But how do you do that?
After you apply for a mortgage, your lender is required to provide you with a Loan Estimate, which provides details about the mortgage, the fees you will pay, and the APR, which can be found on the third page under “Comparisons.” If you have applied with two or more lenders, this is the number you’ll generally use to compare rates.
Also, if you are shopping for an adjustable-rate mortgage, or ARM, it can be difficult to use APRs for comparison purposes. This is because an ARM rate can increase or decrease in the future, so the amount of interest the borrower pays can change, too. That means if rates rise in the future, the APR the borrower sees at closing could be lower than what they’ll actually pay over the life of the loan.
Because certain fees can differ among various lenders, the APR can be different from one lender to the next for the same type of loan. That’s why it’s very important to work with a lender and a mortgage professional you can trust to not only be transparent about the costs you’ll pay and how you’ll pay them, but to also be patient with you if you have any questions.
Have more questions about APRs? One of our mortgage experts at Right by You Mortgage would be happy to help you out. Just give them a call at 1-877-552-2242 or send an email at inquiries@rightbyyoumortgage.com.