When you’re shopping for a mortgage, knowing the annual percentage rate can help you understand the true cost of taking out a loan. APR paints a more complete picture of your costs than the interest rate alone, and is useful when comparing loan offers from different lenders.
Learn what APR means, and how it works:
- What Is APR?
- How Does APR Work?
- How To Calculate APR
- APR FAQ
- The Bottom Line on APR
What Is APR?
APR represents what it costs you per year to borrow the principal on a loan. It includes all relevant loan costs that the borrower must pay as a condition of the loan — such as origination and transaction fees — as well as interest on the loan. It also reflects the loan term and the timing of payments.
Lenders are required to disclose the APR to allow borrowers to understand the overall cost of a loan, and to provide a basis for comparing loan offers.
Interest rate vs. APR: What’s the difference?
The difference between interest rate and APR is that APR represents the cost of borrowing money — including the interest rate. Because of that, a loan’s APR is usually higher than the interest rate.
Why is APR important?
APR measures the cost of a loan more broadly than just the interest rate. Borrowers can use APR to quickly and accurately compare mortgage offers from different lenders.
For example, say one lender offers a low interest rate on a loan but charges fees that make it more expensive than another lender’s loan with a higher interest rate and lower fees. The APRs would allow the borrower to directly compare the costs of each loan.
Where to find a loan’s APR
When you apply for a mortgage, the lender will provide a loan estimate within three business days. This document breaks down the details and cost of the loan you are being offered, including the interest rate, closing costs, fees, and the APR. The loan estimate is a four-page standardized document, and lists the APR on Page 3.
How Does APR Work?
APR includes the mortgage interest rate, which is the annual cost of borrowing money represented as a percentage rate, along with the fees and costs related to the loan.
These fees include but aren’t limited to:
- Broker fees.
- Origination fees.
- Transaction fees.
- Discount points.
- Private mortgage insurance.
What factors affect APR?
Your APR is mostly influenced by fees, which vary by lender, and the interest rate. The interest rate on a loan can be affected by:
- Your credit score.
- The loan principal.
- Your down payment.
- The loan term.
- The type of mortgage.
- Your location.
- The federal funds rate.
- Market conditions.
Keep in mind that buyers can negotiate with their lender up until the loan is finalized. You may be able to get your lender to lower your interest rate or waive some fees, which will reduce your APR.
APR on fixed-rate vs. adjustable-rate loans
Interest rates on mortgages are either fixed or adjustable. Fixed rates don’t change over the life of the loan, while adjustable rates change from time to time depending on market conditions.
The mortgage interest rate is a key factor in determining a loan’s APR, meaning any changes in the interest rate also will change the APR.
How To Calculate APR
Because APR reflects the overall cost of borrowing, you need to know details about the loan — such as the loan amount, interest rate, mortgage term, and fees from your lender — to calculate your rate.
The formula for how to calculate APR is complex, so most people use an online calculator to figure out their rate.
While APR can be helpful in figuring out the rough cost of borrowing money, it’s not a foolproof way to calculate how much a loan costs.
Here are a few limitations of APR:
- Some fees aren’t always included. For example, one lender may exclude home appraisal, notary, or title insurance fees from its APR calculation, while another does not. To better compare loan offers, be sure to find out what fees and costs are included in each lender’s APR.
- APR cannot predict interest rate fluctuations on an ARM. A loan’s APR will change every time the interest rate changes. That makes it less useful as a way to forecast costs over the life of a loan.
Here are the answers to some frequently asked questions when it comes to APR.
While an APR represents the cost of a loan that the borrower must pay, an annual percentage yield — aka APY — usually applies to savings accounts and other investments rather than home loans, and includes compounding interest.
The APR for a mortgage is typically higher than the interest rate because it includes the interest rate as well as the relevant costs and fees that come with the loan.
A good APR is dependent on several factors, including the prime rate, the loan amount, the loan term, and the buyer’s finances. The number itself is less important than whether the loan is affordable and fits into your long-term financial plan.
Even with good credit, the APR might be higher than you expect due to the costs included in the calculation. For example, buying a more expensive home or a home in a high-demand market might mean paying higher fees that would drive up your APR.
The Bottom Line on APR
APR offers buyers a way to compare interest, fees, and overall loan costs across different lenders. While APR doesn’t encompass all homebuying costs, it can be an important tool in deciding which lender to use when getting a mortgage. A potential borrower should shop around, understand their APR, and include it in their decision when weighing loan offers.
T.J. Porter contributed to the reporting for this article.