What is the APR on a mortgage and how does it work?

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If you’re shopping for a mortgage, you’ll likely come across the term APR. Short for “annual percentage rate,” it’s an important concept to understand before you commit to a home loan, especially since it indicates how expensive your loan will be.

So, what is the APR on a mortgage, and how do you know what makes a good one? Here’s what you need to know and how to calculate this percentage.

What is the APR on a mortgage?

The APR on a mortgage signifies the yearly cost of your loan, which includes not just the interest rate but also additional charges like the origination fee, mortgage points and other closing costs. Including these expenses makes the APR a better indicator of the full cost of borrowing money for a mortgage than the interest rate alone. So it’s important to understand this number when comparing lenders to get the best deal for you financially.

What is included in APR?

Keep in mind not all costs are always incorporated in the APR, and the way lenders calculate APR can vary. That’s why it’s important to ask lenders which fees they factor into the APR calculation for your loan.

To give you that all-in cost, here are some of the fees the APR might include:

• Origination fee: This fee covers the cost to create and process your home loan.
• Mortgage points: You can purchase points from your lender to lower your interest rate.
• Some closing costs: These costs, which you can pay at closing or roll into your loan, cover a variety of services necessary to finalize a real estate transaction.
• Private mortgage insurance: If you put down less than 20 percent on your home, you’ll have to pay this extra monthly surcharge
• Underwriting fees: During underwriting, your lender assesses whether you’ll be approved for a mortgage, and these fees cover this service.
• Escrow and settlement fees: You may need to pay a few months’ worth of insurance premiums and property taxes at closing, which will be held in a mortgage escrow account.
• Broker fees: You’ll need to pay these fees if you use a mortgage broker.

Interest rate vs. APR – what’s the difference?

The interest rate is simply the percentage you will be charged on top of the principal to borrow money from the lender. It does not account for any extra fees or charges related to the loan — that’s where the APR comes into play. The APR includes such expenses as mortgage insurance, closing costs, discount points and loan origination fees.

The APR will give you a much better idea of how much each offer will cost overall than just the interest rate. And because the APR encompasses all of these additional costs, it will always be higher than the interest rate. It can give you a good idea of how much the lender is charging you in fees and extra costs.

For example, Bank of America is currently offering 30-year fixed-interest mortgages with an interest rate of 6.375 percent and an APR of 6.652 percent. Similarly, Wells Fargo is offering 30-year fixed-interest mortgages with interest rates of 5.875 percent, but the APR is 6.077 percent.

That’s why it’s crucial to make sure you’re looking at the same thing when you’re comparing offers. Looking at one lender’s APR and another’s interest rate is comparing apples to oranges.

Mortgage APR examples

Many lenders advertise the APR for their loan products, which can help you more accurately compare mortgage offers and costs. While many of the costs are beyond your control, others — like the mortgage points — are at your discretion.

Once you find a mortgage lender, have your loan officer walk you through different APR scenarios so you can make an informed decision. For example:

How to calculate your APR

Good news: You don’t have to do the math here. The mortgage lender calculates the APR for you. If you want to double-check the lender’s work, you can calculate the APR yourself by following these steps:

1. Add up the interest and fees you’ll pay over the loan term.
2. Divide that number by your loan principal.
3. Divide that figure by the number of days in the loan term.
4. Multiply that answer by 365.
5. Finally, multiply that number by 100 to convert the APR to a percentage.

Or, if you want to do things with less pencil-pushing, you can use Bankrate’s mortgage APR calculator. Once you input the loan information, you’ll receive a full amortization, or repayment, schedule, either by year or by month.

FAQ about mortgage APRs

• How can you lower your interest rate with mortgage points?

  One of the ways to lower the interest rate on a mortgage is by doing what’s known as buying points. Mortgage points are essentially an upfront fee you can pay a mortgage lender in exchange for receiving a lower interest rate on your loan. This process allows borrowers to decrease the rate on a loan by about 0.25 percent per point purchased.

• What is a good APR on a mortgage?

  The mortgage market changes on a daily basis, so a “good” APR one day might not be so good the next. Mortgage rates have been dropping of late, so if you’re ready to buy a home and a lender offers you a rate you like, ask for a rate lock. Keep an eye on rates so you understand longer-term trends and what’s considered a fair rate. Bankrate’s mortgage rate tables can help.

• Does my credit score affect my APR?

  Your credit score plays a significant role in determining the APR you’re offered when applying for a mortgage. A higher credit score usually means a lower interest rate, as it signals to lenders that you’re a lower-risk borrower. Conversely, a lower credit score could lead to higher rates due to the increased risk you pose to lenders.

• How is APR different from APY?

  APR represents the yearly cost of a loan, including fees, while annual percentage yield (APY) shows the yearly earnings on an investment, taking compound interest into account. Compound interest impacts nearly all financial transactions, but APR is generally presented for loans, and APY is generally presented for savings accounts, CDs and other investments.

Additional reporting by Mia Taylor