When shopping for nonqualified loans, you may have across the annual percentage rate or APR. It is often quoted alongside the mortgage interest rate. The APR is used in shopping and comparing loans as it is an indicator of a loan’s affordability as a whole. Let’s get to know it and its role in your mortgage decision-making.
What is an APR?
The interest rate and the APR are two different things. You see the interest rate or the nominal interest rate is what is charged when you finance a certain amount.
On the other hand, the annual percentage rate is a combination of the interest rate plus other expenses and charges associated with taking out the loan.
These include closing costs, discount points, private mortgage insurance (depending on your down payment), and prepayment penalties. It is also expressed in an annual percentage rate thus it’s name.
Because the APR takes into account the rate and related loan expenses, it’s higher than the nominal interest rate.
Types of APRs
There are two types of annual percentage rates:
- For fixed-rate loans. The accompanying interest rate doesn’t change throughout the life of the loan.
- For adjustable-rate loans. The accompanying interest rate will adjust from time to time.
APR or Interest Rate?
Each – APR and interest rate – has its way of showing you your mortgage costs. We have the interest rate to show you how affordable your monthly payment will be and the annual percentage rate to tell you how much it will cost you if you take out this loan.
Just by looking at an APR, you can see how expensive or affordable a mortgage can be. If it’s low, it will likely signify lower borrowing costs. But it’s possible for some lenders to charge additional fees or points.
APR and Its Applications
An APR is most potent when comparing long-term loans like 30-year mortgages. It’s because this rate is based on long-term assumptions and the fees spread out during the life of the loan.
That’s why you have to stay in the home during the course of the loan, e.g. 30 years or more to fully enjoy the benefit of a low APR and the low monthly payments it brings. If you plan to move out in a few years, you might want to take out a loan with fewer upfront expenses. Also consider your breakeven point or the time you have recovered the expenses of taking out the loan before you make any move.
Moreover, an APR is not that effective when sizing up adjustable-rate mortgages. ARMs change after their fixed-rate period is over. Even with rate caps, an annual percentage rate is computed based on an assumed rate that is fixed. In the end, it may not truly reflect the borrowing costs of an ARM as its rate goes up or down.
Generally speaking, it’s so much easier to weigh a loan’s merits and compare it with other loans based on APRs, together with the size of your down payment, closing costs and homeownership costs. Best to contact a lender who can explain and help you understand what the annual percentage rate truly means for you.