When you shop for a mortgage, you are likely to hear many terms thrown around, including APR and interest rate. While the two terms sound the same, they are very different. It helps to understand both terms so that you can successfully shop for a mortgage that will be the most affordable for you now and in the long run.
The Interest Rate
The interest rate is the price the lender charges you for borrowing the money. The rate can remain the same throughout the term with a fixed rate. It can also adjust annually with an adjustable rate loan. You’ll always see the rate written as a percentage. In short, you can look at the interest rate as the annual cost to borrow the money, but you pay it on a monthly basis.
The APR is also written as a percentage, so it’s easy to confuse with the interest rate. There is a big difference, though. The annual percentage rate includes the fees that you pay. The fees may include any of the following:
- Mortgage insurance
- Discount points
- Loan origination fees
- Standard closing costs
The APR is meant to give you a good idea of the full cost of the loan over its entire life. It also gives you a good idea of how much the fees affect the cost of the loan. You can then determine what is better, taking a lower rate and paying higher closing costs or taking the higher interest rate and paying fewer fees.
What Should you Use?
So when you shop for a loan, what should you look at, the interest rate or the APR? Unfortunately, there is not a one-size-fits-all answer here. One thing is for certain, if you think you will stay in the home for the entire loan term, you should focus on the APR. This is because the fees included in the annual percentage rate are amortized over the full term, say 30 years. The lender then determines the rate based on the full cost of the loan. If you don’t keep the loan for the full 30 years, though, this is not an accurate figure.
If you know you won’t live in the home for the long-term, you may be better off focusing on the interest rate. Typically, when you are only buying a home for the short-term, you should pay fewer fees upfront. It doesn’t make sense to buy the interest rate down if you will not live in the home for the life of the loan. Instead, you should take the slightly elevated rate. When you focus on the rate itself, you can compare it amongst different lenders to try to save as much money as possible.
Choosing between the interest rate and APR is an important decision. The annual percentage rate offers the best look at just how much you will pay over the life of the loan, but it’s only accurate if you live in the home for the long-term. If your plans are shorter than long-term, your best bet is to focus on the interest rate and finding a lender that is offering the lowest rate for your situation.