So you’re thinking about buying a home—congratulations! It’s a fantastic time to buy, with low local mortgage rates and, in many parts of the country, very motivated sellers. In fact, there may never have been a better time in history to start living the American dream and become a homeowner.
Now that you’ve made that decision and are starting your quest for home loan financing, odds are you’re going to start hearing a lot of terms, like LTV, D/I, PITI, PMI and perhaps the most important: APR. So what the heck is it?
If you were to read a traditional definition of APR it would probably go something like this: “APR, or annual percentage rate, is the effective interest rate (local mortgage rates) you will pay in any given year.” Yeah, that’s clear, right?
I didn’t think so when it was first explained to me, either. So here’s how I like to explain it to my clients:
When you get a home loan—or almost any loan, really—there are three main factors in determining your monthly payment: the amount you borrow, the local mortgage rates you will pay and the term over which you will pay it. Suppose you want to borrow $200,000 over a 30-year period, and your loan officer has told you local mortgage rates for a 30-year loan are 4.5%. Your monthly principal and interest (P&I) would be $1,013.37.*
There’s one other thing you need to consider: the costs associated with your loan. Those include any discount points, origination fees or mortgage insurance you might pay. These will affect your APR.
Suppose those costs total 3% of your loan amount, or $6000. That means that you’re actually paying a P&I payment of $1,013.37 (the same amount) over those same 30 years, but the present value of your loan is only $194,000 ($200,000 less $6,000 is closing costs). And ultimately, that means that the APR of your loan—or the cost to borrow that money—is 4.762%.
Should I just compare local mortgage rates? Or should I also compare APR?
The APR is actually a fantastic way to compare the loan programs that different loan officers may be pitching—and help you decide the right one for you. Let me show you what I mean.
Let’s take that 30-year loan referenced above. You receive two proposals, both showing the same local mortgage rates of 4.5% and the same payment of $1,013.37. The first shows the APR given above: 4.762%. The other shows an APR of 4.717%. You instantly know that the first offer has higher closing costs—in this case $1000 more.
And all things being equal, the lower APR makes the most sense.
Is it always about getting the lowest APR? No. In fact, check out my next blog post, when we look at other things you should consider when evaluating what loan is right for you.
Do you have a question about getting financing for you home? Curious what your local mortgage rates are? Post it below.
*Local mortgage rates and payments shown above are examples only.