When you buy a house, chances are that you’re not paying cash. You’ll need to secure financing in order to pay for it. One of the things that you’ll notice is that the rate and the annual percentage rate (APR) are not the same.
The advertised interest rate is the cost of borrowing money and expressed as a percentage. Lenders must comply with the Truth in Lending Act, which requires that the APR be published as well. This number, also expressed as a percentage, includes the interest rate and:
- Points – both origination and discount
- Underwriting, loan processing and document prep fees
- Commitment fee
- Attorney and/or title closing fees
- PMI (private mortgage insurance) or MIP (Mortgage insurance premium) for FHA
- Prepaid interest
Why APR is important
If you’re considering two different loans with the same rate, the APR lets you know the true and total cost of the loan. The advantage of APR is that it allows you to more accurately compare the cost of borrowing from different lenders, since they may have different fee structures. A lower rate may not be your best option. It is possible that a lender may charge a higher interest rate but lower fees.
Why APR isn’t important
The fees associated with the loan are usually paid up front. It is calculated over the life of the loan, which is usually 30 years. If you’re going to sell your house in a few years or you plan to refinance, the APR may not be as big a consideration to you.
Although interest rate and APR are expressed as simple percentages, the way both are calculated are fairly involved. Make sure to ask your mortgage lender to fully explain all costs and fees of your loan so that you have a good understanding of the total costs.
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