Everyone wants to know they're getting a fair and reasonable mortgage offer. The federal government supports the annual percentage rate disclosure (APR) as the benchmark barometer of loan cost when mortgage shoppers begin their quest to find a good deal on a home loan, which is why it's so important to understand what goes into a mortgage APR and how you can harness this knowledge to find the best loan for you.
Quick APR Tidbits
The annual percentage rate is a disclosure seen in the origination of new credit or in advertisements of various credit products such as loans and credit cards. You won't, however, see APR on a mortgage loan statement as the APR is used as a cost measure at application. APR is simply a function of the costs of the mortgage loan added to the interest rate and re-amortized based on the size of the loan you're seeking over the loan term (e.g. 360 months for a 30-year fixed-rate mortgage). The sole purpose of APR disclosure is to make credit shopping easier.
- The APR does not change your loan amount.
- The APR does not change your payment.
- Your note rate is what determines your principal and interest mortgage payment.
Why Your APR Is Higher Than Your Note Rate
The annual percentage rate is higher than the note rate because APR takes into consideration the fees (whether or not you are actually paying them) adds them to your loan amount and re-calculates the figure over the loan term, thus the APR rate disclosure is higher. This rate vs. APR relationship can seem convoluted because you are not paying the fees based on the APR rate, but rather the note rate, as the note rate is the real cost of funds.
For example, it is not uncommon to see a 30-year fixed-rate mortgage with a note rate at 3.875% and an APR of 4.137%. The 26 basis points spread between the 4.137% and a 3.875% is the fees disclosed as expression of cost based on the size of the loan you are applying for.
APR can be best used to distinguish amongst mortgage offers in order of priority, starting with the highest APR offer, and working down.
Keep in mind that a mortgage with a lower note rate and a higher APR may actually be a lower cost mortgage for you than a loan with a lower APR but a higher note rate. How long you keep the mortgage plays a big role in the cost of the loan.
What You Need to Examine When Comparing Mortgages
- Loan term
- Loan program
- Loan amount
- Note rate
- Total payment
- Closing costs
Remember that examining the APR of a mortgage offer can only help with determining which mortgage offer has better terms and fees. The APR does not take into consideration which mortgage loan makes the most financial sense for you because it is not the driver of your monthly principal and interest payment or closing costs.
Some Extra APR Tips
If you're getting a no-cost mortgage, where your lender is providing a credit for closing costs, the APR is still calculated as though you're paying the fees because your lender must disclose it appropriately to meet federal regulations in the origination of residential mortgage loans.
If the APR is more than 0.25% higher than the note rate, pay closer attention. The majority of the time the mortgage has discount points associated with it, which is by far the biggest driver of higher APR. If you received disclosures that show a substantially higher APR than the interest rate and you don't understand the disparity between the annual percentage rates on your disclosures and/or mortgage quote versus the note rate ask your loan officer. Don't be afraid to ask questions even if they seem silly or redundant.
As a well-informed mortgage consumer, you have a duty to yourself to make certain you understand all of the many intricate facets of the mortgage loan you are seeking. Doing this discovery research will help you make the determination as to which mortgage loan is most suitable for you.
Keep in mind that one of the biggest factors in what determines your note rate is your credit score. Taking some time before applying for a mortgage to build a good credit score can save you thousands over the life of your loan. You can check your credit scores for free on Credit.com to see where you stand and make a plan to improve