What is an APR? Annual percentage rate, explained

What is an APR? The annual percentage rate, or APR, is the amount you’ll pay in interest and other fees when you borrow money (for example, when you get a mortgage or credit card). The APR can also be thought of as the total cost of borrowing over a one-year period.

The “and other charges” clause is key here. When homebuyers get a loan, they’re often obsessed with the annual rate alone, say 5% more than you’ll pay each year for the life of your $ 300,000 loan. But that’s not where your spending ends, and that’s where the APR comes in.

“The APR includes the interest rate and other fees, which is why it is usually higher than your interest rate alone, ”explains Michele Lerner, author of “Buying a Home: Hard Times, the First Time, Anytime”.

What is an APR and what fees are included?

People tend to think of the annual percentage rate as the ‘real’ amount they are paying because it includes all of the major upfront costs associated with the loan (for example, closing costs, points, set-up costs, and private mortgage insurance). It is also known as the effective PRA.

The APR is also your “apple to apple” number when comparing purchase or refinancing loans from various lenders, and prevents you from getting tricked into paying hidden fees. If a lender has a much higher APR for the same percentage rate, that means they are charging you more to borrow money, and you could end up with more debt.

The are some costs that are not typically calculated in the APR, including home valuation, title search, title insurance, credit report, and transfer taxes. (Although taxes are generally considered to be part of the closing costs, they are not a lender’s fee, so they do not count towards the APR.)

That said, appraisal, credit report, title research, and title insurance should normally be relatively minor costs compared to the cost of the loan. Nonetheless, if you are considering two rates that are very close, be sure to consider what is calculated in the APR. Some lenders may not include things that other lenders do.

Interest rate vs APR

So which number is more important, the periodic rate or APR? If you want to make sure you are getting the best loan for your situation and that you don’t get into too much debt, it’s important to consider both disclosures.

“The reason you should be looking at the double digits is that if you are just sticking to the interest rate, you may not know the fees associated with your loan,” Lerner explains. “If you just focus on the APR, you might miss out on a lower interest rate.”

Keep in mind that the fees that are included in the APR are paid at closing. In contrast, your interest rate is what you’ll pay as long as you make monthly payments, which can last up to 30 years, note Stephane Rybak, senior vice president at Guardhill Financial in New York.

Your APR does not include capitalization of interest. Compound interest is essentially “interest on interest”. For example, if you incur interest charges one month and you don’t make payments covering all the interest charges, then you pay interest on the higher balance which includes the unpaid interest. The interest mix is ​​more important for credit card APRs and personal loans, where the amount of interest you pay to the credit card company or bank may multiply as the balance increases.

What determines my interest rate?

Even saving a fraction of a percent on your interest rate can save you thousands of dollars. As the prime rate (the rate that banks charge each other) goes up and down, buy APRs on mortgages and other debt. If you can buy a home when you can lock in a good APR, you’ll save a lot of money on interest charges over the life of your mortgage.

Also, you will find different APRs from different lenders. Shop around to make sure you get the best deal.

Six key factors influence the interest rate offered by most mortgage lenders at any given time:

  1. Credit score: Your credit score is a digital representation of your history of paying off your debts, from credit card debt to student loans. If you have a good mix of credit accounts (for example, one or two credit cards and maybe a car loan) and you pay your bills every month, you should generally have a good credit score. Lenders use your credit score to predict the reliability of your home loan. In general, consumers with a higher credit score receive lower interest rates than consumers with a lower credit score. A perfect credit score is 850, a good score is 700 to 759, and a fair score is 650 to 699.
  2. Loan amount and down payment: If you are willing and able to invest a large down payment in your home, lenders assume less risk and will offer you a better rate. (A 20% down payment makes the lender much more secure than a 10% down payment.) If you don’t have enough money to put down 20% on your mortgage, you will likely have to pay for insurance. private mortgage, or PMI, an additional monthly fee intended to mitigate the risk to the lender that you may default on your loan. (The PMI ranges from about 0.3% to 1.15% of your home loan.) Additionally, depending on your situation or the type of loan, your closing costs and mortgage insurance may be included in your loan amount. ready.
  3. Place of residence: Mortgage rates can vary depending on where you buy a home. Indeed, the strength of your local real estate market can up or drive down interest rate.
  4. Type of loan: Your interest rate will depend on the type of loan you choose. The most common type of home loan is a conventional mortgage, intended for borrowers who have established credit, strong assets, and stable income. If your finances aren’t in good shape, you may be eligible for a Federal Housing Administration loan, a government-guaranteed loan that requires a low 3.5% down payment. There are also loans from the United States Department of Veterans Affairs and loans from the United States Department of Agriculture for rural development.
  5. Term of the loan: The length of your loan affects your rate. In general, shorter term loans have lower interest rates and overall costs, but larger monthly payments.
  6. Type of interest rate: Mortgage rates vary depending on whether you get a fixed rate mortgage or an adjustable rate mortgage (ARM), also known as an adjustable rate mortgage. A fixed rate means that the interest rate you pay remains fixed for the duration of your loan. Meanwhile, an ARM is a loan that starts at a fixed, predetermined interest rate – likely lower than what you would get with a comparable fixed rate mortgage – but the rate adjusts after a specified initial period – usually three, five, seven, or 10 years — based on stock market indices.

How to choose a mortgage that’s right for you

Struggling to choose between interest rate and APR based loans? If you have the cash up front but prefer to have lower monthly payments, it might be worth it for you to shop around for the lower interest rate even if the APR is slightly higher. Ten years from now, you’ll be thankful for that drop in interest when you pay a lower bill.

On the other hand, if you need all of your cash on hand for the down payment, you may need to pay a slightly higher interest rate with less closing costs. It also matters how long you plan to stay in the house.

Every loan has a breakeven point, where the additional charges you have paid up front are offset by a lower interest rate. If your breakeven point for a loan with a higher APR and lower interest rate is seven years, but you plan to sell the house in five years, you get a better deal with a loan with a lower interest rate. higher interest and lower fees.

Ultimately, to get the best deal on a home loan, you’ll want to look at the interest rate, the APR, and any details you can get about the fees that were included (or perhaps more importantly, not included) in these Numbers.

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