If ever you opt to avail of a mortgage to pay for your home, there is nothing more crucial than understanding what the annual percentage rate or APR means. The APR includes not only the interest rate but also points, fees and other charges which a borrower pays for getting the loan. This in a way assists in comparing loans from different lenders which is essential in figuring out which loan is best for you.
What Does APR Include?
The APR includes several components:The APR includes several components:
-
Interest rate. This is the going interest rate that you are charged to borrow the money over the entire term of the loan. The interest rate on a mortgage commonly known as the nominal rate may be fixed or may be adjusted after some time.
-
Points. Some lenders have first charges known as points, with each point being equivalent to 1% of the loan amount. Points are paid when closing and they are effectively a form of prepaid interest.
-
Origination fees. This is a non-refundable fee that the lender may charge for processing, underwriting and funding the mortgage loan. This origination fee is also a component of the APR.
-
Other charges. Any other compulsory charges that are associated with the loan, including application fees, attorney fees, are included in the APR. Property taxes and homeowners insurance are not part of the calculation.
How is APR Calculated?
APR calculations are based on the compound interest calculations that incorporate the rate of interest and points/fees to the real cost of finance charges per year. It operates based on the formula that computes the annual percentage rate on the loan following deduction of the points and fees for the early settlement. There are specific requirements concerning how financial regulators want lenders to determine APR.
If no additional payments and the change in rates are not expected, then the APR gives an idea of how much exactly has been paid in total interest for the given loan. This makes it easier to compare various loans from different lenders with different types of fees and charges.
For example:
Loan 1 has an interest rate of 6/ with no points or fees Loan 2 is at 5. 75%, but 2 discount points are included Calculating the APR with the points as prepaid interest proves that Loan 2 has a higher true cost despite the lower interest rate.
Why APR Matters in Mortgages
Since a mortgage is likely the largest and longest-running loan most people ever take out, ensuring you understand the true cost as represented by the APR is critical:Since a mortgage is likely the largest and longest-running loan most people ever take out, ensuring you understand the true cost as represented by the APR is critical:
-
Compare total cost of loans: APR is the most efficient way to understand which loan type is the cheapest in the long run and not only the basic interest rate.
-
Avoid surprises: In some cases, there can be additional charges of a few thousand dollars to obtain a mortgage, thus the APR reflects all possible expenses that can be incurred in the future.
-
Estimate total interest costs: The base rate is a fixed figure while the APR is an estimate of the total cost of the interest depending on how long it takes you to pay for the loan.
-
Lock in costs: Lenders offer an APR rate during the initial stage of the application process so you are aware of the total costs involved when dealing in that particular lender.
What is considered a good Annual Percentage Rate for a home loan?
The lower the APR then the better for any mortgage or loan that is taken out. A good APR for today’s average 30-year fixed rate mortgages would be in the range of 3-5%. Here are some tips for getting the best APR on your home loan:Here are some tips for getting the best APR on your home loan:
-
Do not limit yourself with just one lender, so you can get the best deal. Inquire about the fees that they include to arrive at their APR quote.
-
It can be dangerous to take a loan from a lender that offers incredibly low rates while neglecting the closing costs as part of the APR.
-
See what published average APRs and mortgage rates are now so you can get an idea of today’s averages.
-
Borrowers with higher credit score and lower debt-to-income ratios should be allowed to access lower rates and costs.
-
Compare the availability of down payment and the types of loans like the 15-year or ARM loan to get the balance of rates and fees as per the desired plan and capacity.
-
Talk to the lenders to request them to remove or decrease some of the fees in order to lower APR.
The Bottom Line
In comparing home loan offers of different lending companies, focusing on the annual percentage rate or APR helps in determining the total cost of the loan in the entire mortgage period. Calculate which interest and fees are the lowest to get the best possible deal. This brings the need to shop around and get the lowest APR that will prevent one from being overcharged thousands of dollars that are unnecessary when owning a home for many years.
