One thing that potential new home owners will immediately recognize is there are a lot of numbers. Perhaps the most important number is the interest rate. The interest rate helps determine your mortgage payment along with the term of the home loan. A lower rate will allow you to qualify for more home. Or, if you’re refinancing an existing loan, a lower rate can save you money each month and throughout the life of the loan.
New buyers will also see numbers reflecting closing costs associated with the loan in addition to the interest rate. There are lender fees and there are non-lender fees. Lender fees might include costs associated with processing the loan application and origination fees. There are fees for an appraisal and credit reports as well as a fee paid to see if the property is located within a flood zone. Non-lender charges are those reserved for title insurance and settlement fees. Property insurance and property taxes area also needed.
Another number, again expressed as a percent, is perhaps one of the most confusing numbers new home owners encounter. This percentage is required to be provided when a lender advertises an interest rate or you apply for a mortgage and the lender quotes a rate tailored to your situation. The APR is a percentage that considers the cost of money borrowed expressed as an annual rate and is used to compare like mortgages between different lenders.
The APR considers not just the interest rate on a mortgage but certain closing costs associated with obtaining the loan. For example, your lender quoted you a 4.00% rate on a 30 year loan. But there’s more to it. According to APR reporting requirements, that 4.00% rate also contains additional fees. You need the rate, but you have to pay for other services needed to obtain the loan. The higher these fees are, the greater the disparity between the interest rate on your loan – the note rate – and the annual percentage rate. Higher costs will create a higher APR for the same interest rate. Let’s look at an example using that same 30 year fixed rate at 4.00% on a $300,000 loan. The mortgage payment is then $1,432 per month based upon your interest rate. But there are also $4,000 in required closing costs associated with that mortgage at one lender. Considering that additional $4,000, the APR is then 4.11%.
Now let’s get a rate quote from the second lender. The rate is also 4.00% but the APR is lower at 4.06%. If you looked at two APR numbers separately, you can immediately tell the second lender has lower closing costs than the first because of the lower APR. In this example, the closing costs are only $2,500, resulting in a lower APR. It’s important to note this comparison only works when comparing the exact same mortgage type. A 30 to a 30 year or a 15 to a 15 year for example.
APRs are used to help consumers make responsible borrowing decisions and lenders are required to disclose the APR when you apply for a home loan. The APR can be confusing, but once you realize how it’s calculated it becomes crystal clear.
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