As fun and exciting as shopping around for a new home can be, comparing and trying to find the best mortgage can instantly suck the pleasure out of the process. There is a seemingly never-ending list of fees, fine print, terms, interest rates, and other factors that all need to be considered before anyone signs on the dotted line.
There has to be a way to simplify the process somewhat, right?
The good news is that there is a statistic and figure that can help you cut down on the confusion and help you determine which mortgage is the best deal for you: the Annual Percentage Rate. (APR)
While using the APR as the only thing you consider when shopping around for a mortgage isn’t necessarily the best or brightest idea, it is a great tool that can help you cut to the chase and figure out what the bottom line of your mortgage will be.
Bringing Rates, Fees, and other Factors Together
Essentially, the APR of a mortgage can take all of the complicated figures involved and roll them into one number. That number is comparable to your interest rate and can show you what the actual cost of your overall mortgage payment will be down the road. All mortgage lenders are required by law to divulge information regarding the APR of any of their loans.
To better understand how looking at the APR should affect your decision; let us take a look at two different examples.
Consider two separate loans that sit at $300,000 with a 5 percent interest. For arguments sake let’s say that the first loan comes without any additional fees while the second loan comes with $10,000 worth of points paid and fees. The first loan sees the borrower simply getting $300,000 at the 5% interest rate, where the second loan is really just a $290,000 loan with a charge of $10,000 added on top.
What the annual percentage rate will do is spread that $10,000 in charges over the term of the loan and consider the fact that the borrower only has $290,000 to play with. That little bit of a difference means that you actually end up paying an annual rate just under 5.5%, as opposed to the 5% rate that you originally agreed to.
Actual Borrowing Costs
As you can see the APR gets down to the nitty gritty and shows you the actual cost of borrowing for your mortgage. It can recalculate all of the terms and fees as a part of the overall interest rate which is what makes it so handy when shopping around and trying to figure out which mortgage loan is the most affordable. Simply looking at the interest rates is not enough on its own.
Consider this. If you have one loan option at 5.5% that comes with $2,500 in fees and 0 points and another loan at 5.25% with $7,000 in fees and 2 points, the APR will actually be higher on the second mortgage that has a lower interest rate.
You can also use the APR to compare mortgages that come with an adjustable rate, even though the rates are not fixed. The APR is calculated based on the full term of the mortgage and assuming that you will pay whatever the new rates are when they fluctuate. While you cannot predict the fluctuation of interest rates, the figures are calculated in terms of the rate index or the base rate.
Drawback to Using the APR
The major issue that comes with relying on the APR to select a mortgage is the fact that it assumes you will hold onto the mortgage for the entire length of the term. If you end up refinancing or selling your home before the end of the term, then the overall interest rate of the loan will end up increasing.
Thus, if you have an idea that you may want to sell your home or refinance it before 10 years then you may want to consider a mortgage that comes with a higher rate and less fees.
Using the annual percentage rate that is provided by your lender is excellent as a rough guide when comparing different mortgages. However if you want to fully understand your loan then you need to find a mortgage calculator and plug in all of the factors such as interest rates, fees, and points in order to find the deal that best suits your budget and your lifestyle.