Applying for and understanding mortgage loans can be a very confusing process for anyone. The terms, the lingo, and the paperwork can become overwhelming very quickly. The resulting confusion often leads to misunderstanding important terms in the application process. You’ll find two terms in particular throughout the entire loan process, and those terms are Interest Rate and Annual Percentage Rate (APR). Since these two words refer to the amount of money you will be responsible for paying, it is extremely important to know the difference between the two and how they relate to your mortgage payments.
Let’s begin with the interest rate, sometimes referred to as the note rate.
The interest rate is the cost, or amount of interest, paid on the loan amount. The interest rate is always expressed as a percentage, and it’s basically the percentage of principal the lender charges you to use their money for your purchase. A number of factors determine your interest rate, including your credit score, current market conditions, loan type and term, loan amount and down-payment amount. When a lender advertises a low interest rate, don’t assume that lender is going to offer you the best deal. Since there are always other fees associated with the purchase of a home, the APR needs to be taken into consideration.
The annual percentage rate, though often confused for interest rate, is much different.
The annual percentage rate shows you the overall big picture. It encompasses the interest rate, closing costs, broker fees, discount points and rebates included in the transaction. The annual percentage rate determines the total cost of your loan with all fees included.
When shopping for loans and working with various lenders to determine what loan is right for you, it is important to know that all lenders need to disclose both the interest rate and the annual percentage rate in their offers. Many borrowers request their interest rate and use only that rate to compare mortgage offers. However, the interest rate will only allow you to determine what your monthly costs are. It will not paint the overall picture of your loan amount including the principal, interest rate, closing fees, etc.
When shopping for a mortgage, it’s also important to factor in how long you plan on staying in the home. Do you plan on staying through retirement, through the term length of the loan? Or is this home a starter home and you plan to eventually move on to something bigger?
You certainly want a low APR if you are staying in the home and paying on that loan long term. However, if you plan to refinance or move in the near future, you can consider paying fewer fees upfront and paying a higher rate (and annual percentage rate) because the total costs that you pay in those first few years could be less.
Yes, this is confusing. Remember you pay APR over the length of the loan, which benefits the owner on a long-term basis.
Determining the best option for you and your particular circumstances can be very confusing. Always ask your lender questions to fully understand the terms of the loan offered to you.