Key Points
• APR, or annual percentage rate, includes the interest rate and additional loan fees, providing a comprehensive view of costs.
• Examining different loans’ APR can help in making comparisons between loans.
• When comparing APRs, it’s important to consider your financial plans and the duration of intended home occupancy.
• APR differences highlight total costs but may not accurately compare fixed-rate and adjustable-rate mortgages.
Table of Contents
What Is APR?
APR stands for annual percentage rate, and it’s used to measure the cost of borrowing money from lenders for various reasons, such as with a home loan. While it’s often presented at the same time as your interest rate, it isn’t the same thing.
APR is expressed as a percentage and takes into account not only the interest rate but also many of the costs that are associated with the loan. When it comes to borrowing using a mortgage, these costs can include such items as these:
• Origination fees
• Application fees
• Processing fees
• Mortgage points, also called discount points
APR provides a more comprehensive picture of the total cost of the mortgage loan. It gives you an overall view of the fees and costs you would have to pay that are included in the finance charge. If you compare just the interest rate, the additional fees and costs aren’t represented, which could give you an incomplete picture when it comes to determining the actual cost of the loan. That could negatively impact your ability to budget accurately for your home loan costs.
Since not all lenders charge the same fees or interest rates, comparing APRs is usually a better way to compare the total cost of your loan from one lender to another.
Why Is APR Important When Taking Out a Mortgage?
Knowing the APR can help consumers be more informed while comparison shopping for loan products. Thanks to the Truth in Lending Act, lenders are required to disclose the APR of their loans, as well as all fees and charges associated with a loan.
The APR should include all finance charge fees, which can make it easier for borrowers to sort through loan comparisons to find the right mortgage.
How Are Interest Rates Calculated?
As we’ve discussed, APR and interest rate aren’t the same, but your interest rate does impact your APR. So, how exactly are interest rates calculated?
Your interest rate is a percentage of your mortgage rate. What that percentage will be depends on what type of mortgage loan you have.
• With a fixed-rate mortgage, you’ll pay the same interest rate for the entire time you have the loan.
• With an adjustable-rate mortgage, on the other hand, your rate will fluctuate throughout the life of the loan.Also, keep in mind that any unpaid interest gets added to the mortgage principal. This means you’ll have to pay interest on that interest.
Your lender will determine your specific interest rate based on your financial details, such as your credit score, as well as the current economic conditions and market interest rates. “Working to build your credit score before applying for a home loan could save a borrower a lot of money in interest over time. Lower interest rates can keep monthly payments down or help you pay back the loan faster,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. Lenders usually use their own unique formula to calculate interest rates, which is why your rate can vary from lender to lender — and why it’s important to shop around for rates.
Recommended: APR vs. Interest Rate: What’s The Difference?
How to Calculate Your APR
When you’re getting a mortgage, you may want to be extra thorough and calculate the APR yourself. There’s a way to make that happen. Be warned, it’s not necessarily a super fun math project, but hey, where there’s a formula, there’s a way, right?
• To get started, you’ll have to know the approximate monthly Principal and Interest (P&I) payment on your loan. Maybe your lender has already told you what it would be, but if not, you could calculate it with an online mortgage calculator or by hand.
• You’ll need to have a loan amount, interest rate, and a term in years.
• Once you have the monthly P&I payment calculated, you’ll then be able to calculate the APR, which you can do with an online calculator. Keep in mind that because you don’t know what your applicable APR loan fees will be, it can be wise to use a ballpark estimate. If the loan costs that will impact your APR are 2% of your loan amount and your loan amount is $200,000, your loan costs for calculating the APR will be $4,000.
The formula for calculating APR looks like this:
[({Fees + Total Interest} ∕ Loan Principal) ∕ Total Days in Loan Term] ✕ 365 ✕ 100
💡 Quick Tip: Lowering your monthly payments with a mortgage refinance from SoFi can help you find money to pay down other debt, build your rainy-day fund, or put more into your 401(k).
Why You Need to be Careful When Using APR to Compare Mortgages
When you’re getting a mortgage, you will likely have the APRs for all the mortgage offers you’re considering. Your APR is important to consider because it factors in the expense of additional fees over the life of your mortgage. If you’re applying for a 30-year mortgage, those fees are spread over 30 years.
But do you plan to live in your home for the full 30 years of your mortgage and never refinance your mortgage? If you sell your home after five years, rather than staying for the duration of your 30-year loan, you’ll still have to pay for the loan fees (such as origination fees).
That’s why it’s important to consider and compare APRs when choosing a mortgage. If you plan on living in the home for a limited time, a lender that offers fewer fees might be a better choice than a lender with a low interest rate but lots of fees. You may want to consult with your financial advisor before making this decision.
When you’re mortgage shopping, especially if you are a first-time homebuyer, you also may want to proceed with caution when comparing the APRs of fixed-rate and adjustable-rate mortgages if you are using an online calculator. The APR on adjustable-rate loans may not be an accurate representation of the cost of the loan since calculators cannot anticipate the frequency or amounts of the interest rate changes.
Recommended: Tips When Shopping for a Mortgage
The Takeaway
When getting a home loan, your interest rate and APR, or annual percentage rate, are not the same thing. The APR reflects the overall cost of the loan, including various fees, for instance.
If you’re ready to take the next step in your home-buying journey, you’ll want to take stock of your mortgage options. Comparing each loan’s APR is a quick and easy way to see how your offers stack up, although it isn’t the only factor to take into account.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
FAQ
What is a good mortgage APR?
A good APR is one that falls below the current average for the type of loan you have chosen. Simply search online for “national average APR” and your loan type (such as “30-year fixed-rate mortgage”) and you’ll see the current rates.
Is it better to have a low interest rate or low APR?
Whether it is better to have a low interest rate or a low APR depends in part on how long you plan to stay in the home. If you have high upfront costs for a loan and then sell the home in just a few years, the APR won’t reflect your overall cost as well as it would if you stayed for the full term of your loan. If you don’t plan to own the home for very long, you might be better off focusing on choosing the loan that gets you the lowest interest rate.
Can I negotiate a mortgage interest rate?
You can negotiate a mortgage interest rate by shopping around and comparing offers from multiple lenders, examining both the interest rate and APR on the loans. Once you narrow the field, you might be able to purchase mortgage points, also known as discount points, to reduce the rate further. But the best way to help ensure a low mortgage rate is to cultivate a strong credit score before you apply for a loan.
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*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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