APR FAQ's

APR Frequently Asked Questions. Answered in Layman's Terms.

The APR or Annual Percentage Rate on a mortgage transaction raises lots of questions. I'll try to answer these in a user friendly non-technical manner. I'm going to lay these out in layman's terms as much as possible. If you want the legal terms or more in depth explanations go ahead an look at www.federalreserve.gov .

What is the APR?

OK, Let's start with the basics. The APR is a mathematical equation that includes the costs of the loan AND the actual interest rate of the mortgage. This number is required to be disclosed on the Truth in Lending Statement and is disclosed as a percentage. This is not actually your Note Rate and the number doesn't determine your monthly payments. Confused Yet?

Why is my APR higher than the Interest Rate my Banker told me?

Think of it this way- You are going to pay maybe $100,000 of interest on that 30 year mortgage, but you also had to pay $2,500 in fees to get the darn thing started right? So it's really costing you $102,500 to borrow the money for your home. The APR tries to take into account the extra fees you had to pay to start the mortgage process. This should make it easier to compare different offers from different lenders. Please note, the APR is almost always higher than your actual Mortgage Note Rate, this is because it's adding in the costs of the loan. 

When I pay my closing costs upfront does it change my APR?

Yes, slightly. I've seen a few answers to this question that indicate that the APR would be the same whether or not the costs are paid at closing in cash or rolled into the loan. This is mathematically untrue. If you roll the costs of the mortgage into the loan you will do 2 things- #1 you will actually pay more interest on the loan and #2 you will have a slightly different APR, I've actually seen it get better. 

It makes sense, if you take a larger loan amount you will indeed pay more interest. There is no way of getting around this. If the costs of the loan are rolled into the mortgage you will have to pay interest on that additional amount. The mortgage company doesn't separate out the costs of the loan into an interest free account, it's all lumped in together. 

If you roll in the costs or even take a little bit of cash out of the loan, the APR could actually go down. This is true on a 30 year note with fairly low closing costs. This is true because the costs of the loan will cause the overall loan amount to rise and the equation calls for the closing costs to be amortized over the life of the loan and absorbed into the loan amount. For an exaggerated effect think of it this way - $2000 is a fairly large percentage of a $100,000 loan (2%) but it's a small percentage of a $400,000 loan (.5%). The larger the loan amount, the lower the APR adjustment is. Sometimes if you increase the loan amount, the APR will be a little bit lower. 

How do I use the APR to Shop for a Mortgage?

Make sure that the scenarios you present all have the same parameters. If you know you are going to waive escrow's say that upfront. If you know you will pay off the home early take that into account. Remember that the Closing Costs are impacting the APR by spreading them out over all 30 years, if you intend to pay off the home or sell in 7 years those closing costs have to be accounted for over 7 years instead of 30. If all terms are equal and you intend to pay off your home free and clear some day, the lowest APR will typically be the way to go. 

When a loan goes from including escrows to having an escrow waiver does it impact the APR?

Sort of. Most lenders charge an extra fee to waive escrows which will impact your APR. 

Is the APR actually how much I'm paying for my home? 

The APR represents the costs of the loan over the entire term of the mortgage. In many cases this is 30 years. Do you want to know how much you are paying for your mortgage though? Add up the entire payments on the mortgage and subtract out the actual purchase money needed for the home to close and add in any closing costs paid out of pocket. That's how much you paid to borrow money and buy a home. Granted, some of those costs you'd probably spend even if you didn't have a home loan, even if you were paying for a home in cash you'd probably get it appraised and pay some title fees. In general though -

(Total Mortgage Payments +Down Payment on the Home+Lender Costs Paid at Purchase Time)- Actual Purchase Price of the Home= Costs of Borrowing Money

I still dont get this APR thing.. Can you tell me more?

Yes, let's make this interactive. Place a question in the comments below and I'll get it answered and added to this posting.