Your APR, or Annual Percentage Rate, is an important term for any potential homebuyer to know. Distinct from your interest rate, your mortgage APR tells you the overall cost of your mortgage loan, taking into account both your interest rate as well as any additional costs.
Understanding what an APR is and how it can impact your loans is critical when borrowing any loan, especially a mortgage. Here’s a primer on what elements make up an APR and how you can calculate it.
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 your mortgage 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 a mortgage, these costs can include items such as origination fees, application fees, processing fees, discount points, and other types of fees that lenders may charge.
APR provides a more comprehensive picture of the total cost of the mortgage loan since 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.
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. For instance, 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 specifics, such as your credit score, as well as the current economic conditions and market interest rates. 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
If you 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. And remember, right now, we’re just trying to give an idea of the difference between the interest rate and the APR.
Once you have the monthly P&I payment calculated, you’ll then be able to calculate the APR, which you can do with this calculator . Keep in mind that because we don’t know what your applicable APR loan fees will be, we suggest using a ballpark estimate. Let’s say that the loan costs that will impact your APR are 2% of your loan amount. So, if your loan amount is $200,000, your loan costs for calculating the APR will be $4,000.
Why You Need to be Careful When Using APR to Compare Mortgages
So you’ve got 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 APR but lots of fees. You’ll want to make sure to consult with your financial advisor before making this decision.
When you’re mortgage shopping, 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 some calculators cannot anticipate the frequency or amounts of the interest rate changes.
Recommended: Tips When Shopping for a Mortgage
The Takeaway
If you’re ready to take the next step in your home-buying journey, the first step is taking stock of your mortgage options. Comparing each loan’s APR is a quick and easy way to see how your offers stack up but remember it isn’t the only factor to take into account.
One way to start the process of mortgage shopping is by checking out mortgage loans from SoFi. We offer a variety of mortgage loans, so you can select the option that works best for you. You can start the application online and find out if you’re pre-qualified in just minutes.
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