Description: Understand what mortgage APR is and what its functions are. The APR can work as a useful tool for you to compare home loan options.
Understanding mortgage loan annual percentage rate
When you request for a home loan, the lender is bound to inform you about the interest rate along with the Annual Percentage Rate or APR.
However, what precisely is the APR? The APR indicates the overall cost of borrowing a home loan and it is expressed as a percentage. This number has been planned to help borrowers shop for mortgages by making them simpler to compare. By using the Annual Percentage Rate, you can compare same types of loans (loans with equal repayment terms or amounts) and choose the one that is right for your budget. To be precise, you can compare apples to apples. You can use an APR calculator to work out Annual Percentage Rates of different home loans and compare them.
How to grade a loan
The APR calculates the net effective cost of taking out a loan. In other words, the Annual Percentage Rate answers the question: “Is it sensible to spend more money on upfront fees for obtaining a lower rate?” The Federal Government has made it compulsory for the lenders to advertise the APR since loans are often offered at various terms. It might be difficult for a borrower to differentiate loan terms from various lenders and select a loan that is right for their needs. The APR can help you choose the right loan.
For instance, you might obtain the following two quotes for a mortgage amount of $150,000, each for a repayment term of 30 years:
Lender X offers 6.5% where the borrower is not paying any discount points and paying $5,000 as fees
Lender Y offers 6.25% where the borrower is paying $5,500 as fees and one discount point ($1,500). So the total is $7,000 in fees and points.
Lender Y is offering a lower interest rate but they are asking for $2,000 extra in fees and points. Then which is the better offer? The APR can give you the answer. By using an APR calculator, you would find out that the Annual Percentage Rate of lender X is 6.83% and at the same time, the APR of lender Y is 6.71%. As the APR of lender Y is less, it is a better offer in the long run.
Take into account the repayment term
An offer that is beneficial in the long run might not be so in the short run. For a short term period, the offer made by Lender X is more beneficial. The offer made by lender Y comes to you with a lower Annual Percentage Rate, but you have to pay $2,000 extra as cash. If you don’t have the cash or you require it for any other purposes, what option would be left for you? In these circumstances, you might opt for the loan offer made by lender X in spite of its higher APR and interest rate. If you plan to shift within a small time period, you would see that the loan offer made by lender X would be cheaper for you.
In contrast, if you intend to stay in your home for the entire loan term, then the offer made by lender Y would be cheaper.
The Annual Percentage Rate takes into consideration some costs of obtaining the loan like points, mortgage insurance and other loan fees. It doesn’t take into consideration particular fees like late payment fees, nonrefundable application fees, title examination fees, title insurance premium, document preparation fees, appraisal fees and so on.
The Federal Truth in Lending Act (TILA) necessitates the lender to disclose the Annual Percentage Rate together with the nominal rate. The nominal rate can’t be advertised more prominently than the Annual Percentage Rate.
The Annual Percentage Rate doesn’t need to be absolutely precise. The lender can round the number up or down to the closest 1/8th of a percentage point.
