Annual percentage rate, or APR, should always be checked before shopping for a mortgage loan. In fact, APR is a primary indicator of the quality of your mortgage deal. But if you don’t fully understand it, it could make it difficult to use as a comparison tool. So, what exactly is APR and how does it factor into my loan decision? Let’s dive in.
What is APR?
Annual percentage rate is calculated as the periodic interest rate multiplied by the number of compounding periods in a year. Since the APR has to include certain non-interest charges and fees, calculations must be done with great detail. In general, APR is calculated by including mortgage lender fees and other items that will affect your monthly payment, such as a private mortgage insurance (PMI). However it’s important to note, it does not consider monthly escrow payments to homeowners insurance or property taxes.
The APR is required to be disclosed to the borrower within 3 days of applying for a mortgage. This information is typically sent to the borrower via mail, and can be found in the lending disclosure statement (which also includes an amortization schedule).
Annual percentage rate is often confused with interest rates, because like an interest rate, the APR is expressed as a percentage. Unlike interest rates, APR includes discount points, lender origination costs, and private mortgage insurance costs and fees in the calculation. APR is confusing to calculate, and details on just how convoluted it is can be found on the FDIC website. Luckily, regulations by the Consumer Financial Protection Bureau (CFPB) have made an effort to ease the complexity for calculating and understanding APR.
How should I weigh APR when understanding loans?
While APR is an important factor in understanding a loan, it’s just one of many. Above all else, the affordability of your monthly mortgage payment should be your number one priority. Other key factors include the right loan term and mortgage type.
If you’re looking to shorten your down payment, expect to see a higher annual percentage rate. The amount you put down could affect your risk to the lender, causing your mortgage insurance to be higher. Higher mortgage insurance premiums result in higher APR’s almost every time.
In short, annual percentage rate can be a great tool to shop mortgage lenders, as long as you’re comparing them accurately.
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