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How the APR for a Mortgage Works
The Annual Percentage Rate (APR) for a mortgage is designed to make it easier to compare loan terms for different lenders. In short, the APR is a single percentage rate that shows what your interest rate would be if it included all upfront lender and closing costs, such as points, origination and processing fees. Instead of comparing multiple loan terms for several lenders, the APR is a single figure that you can use to compare both the mortgage rate and closing costs for a loan. For example, if two lenders are quoting you the same mortgage rate but different closing costs, the loan with the higher closing costs will have a higher APR.
Lenders are supposed to provide an APR any time they quote or advertise interest rates. You can also find the APR on the top of page three of the Loan Estimate document that a lender must provide to a borrower within three business days of submitting a loan application. Many lenders also provide a Loan Estimate when you shop for a mortgage and request a loan quote.
It is important to understand that the APR is not your mortgage rate and does directly impact your monthly mortgage payment. For example, two mortgages could have different APRs but the same mortgage rate and therefore the same monthly payment. Your monthly payment is solely determined by your mortgage rate.
The idea behind the APR is that it is easier to compare one number rather than several numbers when you evaluate mortgage proposals. Some lenders may charge a higher mortgage rate but lower closing costs while other lenders charge a lower rate but higher costs. The APR is one figure that takes into account these differences in loan terms. The problem with the APR for a mortgage is that it is relatively challenging to understand the formula used to calculate it, which confuses many borrowers. For example, some of the inputs for the APR change depending on the length of the mortgage and loan program.
Even if you do not totally understand its mathematical formula, the APR is still a valuable tool for comparing mortgages. In the simplest of terms, the higher the interest rate, the higher the APR and the higher the lender fees and non-recurring closing costs, the higher the APR. If you keep these general rules in mind, the APR can help you select the best loan terms or avoid high closing costs, which can save you a significant amount of money on your mortgage.
If the APR is close to your mortgage rate then you know that the mortgage closing costs, including lender fees, are relatively small. For example, if your your mortgage rate is 4.375% and your APR is 4.400%, then your closing costs are low. If the APR is much higher than your mortgage rate then you know that the closing costs are relatively high and you may want to negotiate lower costs or change lenders. Or if a lender is promising you a "low fee" mortgage and the APR is significantly higher than the mortgage rate then you know something is wrong and to avoid that lender. If your loan has no lender costs, points or fees, the APR will equal the mortgage interest rate.
Please note that if you pay mortgage insurance upfront at the time your loan closes, such as for an FHA, VA or USDA loan, then that fee is included in your APR. That is why the APR for these programs is usually higher than the APR for a conventional loan that does not require upfront mortgage insurance, even though these programs often have lower interest rates.
The table below shows the APR, mortgage rates and closing costs for lenders in your area. The table demonstrates the the APRs are higher when the lender charges higher fees and how the APR equals the interest rate when the lender charges no fees. We recommend that you contact several lenders in the table to request mortgage proposals. Comparing loan terms, including APRs, for multiple mortgages enables you find the loan with the lowest combination of interest rate and closing costs.
The example below shows an APR for a $380,000 fixed rate loan with a 4.250% mortgage rate including lender fees, non-recurring closing costs and daily interest charges (interest expense from the day the mortgage closes until the end of the month in which it closes). The example shows that lender fees, other non-recurring closing costs and daily interest charges are included in the APR calculation. In this case the APR of 4.339% is relatively close to the interest rate of 4.250% which means the up-front mortgage costs are relatively reasonable. If the APR was 5.00% instead of 4.339% then we could conclude that the mortgage closing costs are relatively high.
Use our free personalized mortgage quote form to compare loan quotes from leading lenders. Our form is easy-to-use, requires minimal personal information and does not impact your credit. Comparing lenders is the best way to find the loan that is right for you.
Sources
“What is the difference between a mortgage interest rate and an APR?” CFPB. Consumer Financial Protection Bureau, November 15 2019. Web.
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