APR vs the loan Rate

Closing costs and lower rates-what to know.

Why isn't the lowest interest rate always the best option? Initially, lower rates typically entail higher lender fees (points & garbage fees many large lenders charge).  However, it's important to consider a break-even point when factoring in these points and fees. For instance, if obtaining a specific rate costs $5k while a higher rate comes at no cost but results in a $100 higher monthly payment, it could take up to 50 months to reach the break-even point!  Given that the average loan duration is 36 months or less, this scenario doesn't seem logical.

Why do lenders promote extremely low rates along with numerous points and fees?

They do so because they understand that the majority of consumers only consider the interest rate and neglect to calculate the overall costs.  Regrettably, this marketing tactic proves to be highly effective on many individuals.

What is the Annual Percentage Rate (APR)?

Not only do lenders charge interest on the principal amount of a mortgage, they also may charge upfront lender fees for a particular rate in the form of points and other fees (called loan pricing). The APR considers these additional costs and some additional "impact fees" related to borrowing.  This annual percentage rate reflects the total cost of your mortgage, including the interest rate and various fees associated with purchasing or refinancing a home. These impact fees may encompass prepaid interest, discount points, origination fees, mortgage insurance or PMI, and other closing costs such as certain title company fees. The APR provides a comprehensive assessment of the annual net cost of your loan and can be rounded to the nearest one-eighth of a percentage point.

But watch out!!!  Many online lenders and even big well known lenders under-disclose and misrepresent these APR impact fees at the beginning--while you are rate shopping-- resulting in an initial lower "false" APR tricking you into thinking they offer the best deal.  Since the APR can change prior to closing, they bait the hook with these lies and then before closing they switch and increase these impact fees and even lender fees resulting in a higher final APR than the one you could have received from an honest lender.

Mortgage Interest Rate vs APR

Upon applying for a mortgage loan, federal law mandates that the lender must provide you with information on both the interest rate and the annual percentage rate (APR). This allows borrowers to compare loan offers from different lenders. Nevertheless, your monthly payment is determined by the loan's interest rate.

​How about the lowest APR?

Typically, the higher the lender fees you pay, the lower the APR will be. Having a low APR may seem appealing, but did it result in the most favorable financial outcome?  Consider the duration of your stay in the property.  It is not uncommon for individuals to incur extra closing expenses in order to secure a slightly reduced interest rate. However, upon closer examination, it could take up to 5 maybe even up to 10+ years to offset the extra lender fees associated with that lower rate through the reduced monthly payment.

Limitations of the APR

​ Two identical loans may have different APRs due to variations in the  impact fees used by different lenders to calculate the APR.  Lenders have a bit of discretion to decide which fees and costs are included in the APR calculation, so it is important to carefully compare loan offers. For identical loans, the prepaid interest – and consequently the calculated APR – may differ depending on the closing timing of your purchase (or refinance) transaction. Closing later in the month will reduce the prepaid interest thus lowering impact fees and the APR.

The calculation of APRs on ARMs depends on whether the initial rate is fully indexed, discounted, or premium. It is not uncommon to see the APR lower than the mortgage rate for ARMs. When calculating the APR on ARMs after the fixed rate period, lenders must use the rate that would apply if the loan were to adjust at the time of offer, assuming that rate remains constant for the subsequent years after the initial period.

The APR should only be used to compare similar loan products with same mortgage amount and length.  For example, you shouldn’t compare the APR of a 30-year fixed rate mortgage to that of 5/1 ARM.

Having a lower APR does not automatically indicate that one of the two loan offers is superior. It is important to also take into account the duration for which you intend to maintain that particular loan.​ APR calculations are based on the assumption that you will hold the mortgage for the entire loan term. If this is not the case, upfront costs may escalate the actual cost of your loan and raise the APR as a result of a shorter loan duration.