APR: Annual Percentage Rate in Regards to Home Loans
What Is the APR on a Home Loan?
Unfortunately, when you get a home loan, you pay for more than just the interest rate each month. This is because there are other fees and charges involved in the mortgage process. The APR (annual percentage rate) of the loan reflects these charges, and is a broader measure of the cost of borrowing money to purchase a home.
The Difference Between Interest Rates and APR
One important distinction to make is the fact that an interest rate specifically tells you how much interest you will pay each month on the principal of your loan, while APR looks at the overall annual costs of borrowing as a percentage.
What Charges Does APR Calculate?
In addition to the basic interest rate of the loan, the APR takes into account factors including:
Mortgage points: These represent prepaid interest on a loan designed to reduce the loan’s interest rate. Typically paying off 1% of the loan in advance counts as 1 point.
Loan origination fees: These fees are usually between 0.5% and 1% of the loan, and are higher for higher-risk borrowers, such as those with poor credit. Loan origination fees are often negotiable, and many lenders may offer 0% loan origination fees for highly-qualified borrowers.
For example, if you’re taking out a $300,000 mortgage at 4%, and there are $10,000 worth of fees, APR will take that combined amount, $310,000, and use it to calculate a new mortgage payment. $310,000/$300,000= 1.033. 1.033 *4% = 4.133% APR.
How to Use APR to Make Smart Mortgage Choices
In essence, APR spreads the upfront costs of a mortgage over the life of the loan. That may not matter if you’re keeping your home forever and keep your original mortgage until you pay if off. But, if you’re planning to sell your home or refinance after a few years, APR may not be the most accurate measure of your expenses, since it might make paying more money upfront look better when it’s really not. Basically, look it APR, but you don’t think you’ll be staying with your home (and your loan) for a while, you might not want to pay too much upfront.
APRs on HELOCs vs. Other Loans
If you’re interested in tapping your home’s equity with a home equity line of credit (HELOC), one thing to potentially watch out for is the fact that APRs for HELOCs are calculated differently. In particular, HELOC APRs do not include fees, which may cost you significantly more. So, while an APR is still a decent judge of a HELOC’s cost, it doesn’t quite tell the full story.