Rate Your Mortgage
When you apply for a mortgage, the lender is required to tell you the interest rate and the annual percentage rate, or APR. But what exactly is the APR? The APR is designed to help you shop for loans by making them more comparable. It’s the one common denominator by which you can compare loans side by side, comparing apples to apples to apples. APR measures the net effective cost of borrowing; the actual present value of those funds over the length of the contract.
The federal government requires lenders to quote APR because loans frequently are offered on different terms. To extend the fruit analogy, differing loan terms from different lenders can make it hard to figure out which offer is a sour persimmon and which is a sweet peach. APR helps you identify the peaches.
For example, consider the following two quotes for a $150,000 mortgage, each for a 30-year term:
- Lender A offers 6.5 percent with the borrower paying no discount points and $5,000 in fees;
- Lender B offers 6.25 percent with the borrower paying 1 discount point ($1,500) and $5,500 in fees, for a total of $7,000 in points and fees.
Lender B offers a lower interest rate (or “nominal rate”), but for $2,000 more in points and fees.
Which is a better deal? APR gives you a general idea. Lender A’s offer has an APR of 6.83 percent, while Lender B’s offer has an APR of 6.71 percent. Since Lender B’s APR is lower, that loan is a better deal in the long run. But that’s in the long run.
In the short run, Lender A’s offer might be better. A look at the examples above tells why.
Lender B’s offer carries a lower APR, but you, the borrower, have to come up with $2,000 more in cash. What if you don’t have the money? In those cases, you might prefer the first loan, despite its higher percentage rate and APR. On the other hand, if you plan to remain in the house for the life of the loan, don’t even look at the nominal rate. What you really want to know is what the net effective cost of funds is, and that’s APR.
Related posts:
