Mortgage Rate vs. APR

May 31, 2011 No Comments »
Mortgage Rate vs. APR

If you’ve seen a certain mortgage rate advertised lately, you may have noticed two percentages.

But why? Well, one is the mortgage rate, which is the interest rate you’ll pay every month (assuming you actually qualify).

And the other is the APR, which is the interest rate factoring in certain costs, such as processing, underwriting, loan origination fees, mortgage insurance premiums, and so on.

Third-party fees, including title insurance and appraisal fees, typically aren’t included.

The APR is basically the true cost of the loan, or at least a bit more accurate than a simple interest rate.

Let’s look at an example:

Mortgage Rate X: 4.50%, 4.838% APR
Mortgage Rate Y: 4.75%, 4.836% APR

The advertised mortgage rate “X” is 4.50%, but requires that two mortgage points be paid – it also has $2,000 in additional closing costs, which pushes the APR to 4.838%.

Meanwhile, advertised mortgage rate “Y” is offered with no points and just $1,000 in closing costs, so the APR is 4.836%, just below that of mortgage rate “X.”

So even though one advertised mortgage rate may be lower than another, once costs are factored in, it could actually end up being higher.

APR Limitations

Though it’s extremely important to know both the mortgage rate and the APR, there are limitations.

Some costs aren’t included in the APR, and banks and mortgage lenders calculate APR differently, so it’s not always simple to get an apples-to-apples comparison.

Additionally, APR assumes you’ll hold the loan for its full amortization, but most people sell or refinance long before loan maturity.

So high cost loans held for a short period will actually result in a higher APR than advertised, because the costs aren’t spread over the full term.

Watch Out for APR on ARMs

If you’re shopping for an adjustable-rate mortgage, you may see that the APR is lower than the mortgage rate.

This is essentially because lenders calculate the fully indexed rate (once it adjusts) by combining the margin and associated mortgage index.

And since mortgage indexes are so low at the moment, they assume you’ll have a lower rate once the loan adjusts, which may or may not be the case.

Don’t bank on the fully indexed rate being lower, because rates are historically rock-bottom and probably won’t stay that way for long.

Tip: Are mortgage rates negotiable?

Compare Today’s Mortgage Rates

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