The Difference between APR and Interest Rate
Interest rate is the monthly rate that you pay on your remaining balance of the loan – it’s the actual rate. Your Annual Percentage Rate (APR) includes your interest rate and other miscellaneous costs. Those costs can include monthly mortgage insurance, processing or underwriting fees (ask about our no-fee loans), discount points, origination fees, and more.
Mortgage Insurance Highly Impacts APR
If you’re putting less than 20% down and have monthly mortgage insurance, this could greatly impact your Annual Percentage Rate. This is because the APR will assume that you have your monthly MI for as long as possible. Even though you may be getting rid of your mortgage insurance in 4-5 years on a conventional loan (assuming on time payments, increased value, etc), it assumes that it stays on for the life of the loan (which could happen if you had missed payments here and there) which could be 30 years.
Don’t always shop by APR, as some lenders can take advantage of borrowers that are solely relying on it as their only shopping tool. Here are a couple examples where it may misguide someone shopping and comparing loan options.
Example #1 – Lower Rates, Higher Fees can still be Lower APR
If you end up paying less fees and interest over 30 years with one mortgage over another, it’ll have a lower APR. Here is an example on a 30 year mortgage…Lender A is quoting a 4.000% rate (4.451% APR) charging $6000 in fees while Lender B is offering a 4.500% rate (4.500% APR) charging $0 in fees. If you kept the mortgage for 30 years, Lender A’s mortgage will have a lower total cost. However, it’s rare that people keep their mortgages for a full 30 years. Some people sell their homes, some refinance down the road, and some pay down their mortgage sooner. For most people, Lender B’s mortgage would make more financial sense. Unfortunately, some predatory lenders use tricks to fool consumers (typically on a refinance where fees are being rolled in).
Example #2 – Mortgage Insurance Options
If you’re putting less than 20% down on a conventional mortgage, borrowers typically have a few options. One is monthly mortgage insurance, meaning a lower rate and a monthly fee that can get taken off later. Another option is a single upfront fee with no monthly cost. Lastly, there is lender-paid mortgage insurance, which has a slightly higher rate, but no monthly cost and no payment drop down the line. Out of all these, the monthly mortgage insurance is likely to have the highest APR cost because it assumes it stays on the longest it possibly can, which is unrealistic.