What Is The Difference Between APR And Interest Rate?
Written by Gustan Cho
Residential mortgage lenders, whether they are banks, credit unions, mortgage bankers, or mortgage brokers, are required to disclosed the annual percentage rate, also known as the APR. Mortgage lenders will advertise the interest rate but they also need to disclose the annual percentage rate, the APR, which includes the total costs associated with the mortgage loan. For example, say mortgage lender A will quote a particular mortgage rate on a $200,000 residential mortgage loan at a 4.25% interest rate on a 30 year fixed rate mortgage loan and the cost associated with the origination of that loan is $2,000. Another mortgage lender, Mortgage Lender B, will quote the same rate of 4.25% on the same $200,000 mortgage loan amount, however, the cost of Mortgage Lender B is $5,000. Although both mortgage lenders have the same interest rate of 4.25% on the $200,000 mortgage loan, Mortgage Lender B will have a higher annual percentage rate, APR, due to the higher costs associated with the mortgage loan. The annual percentage rate, APR, is required to be disclosed by mortgage lenders so consumers can compare and shop for the actual costs in obtaining a residential mortgage loan.
How Is The Annual Percentage Rate Calculated?
The annual percentage rate is calculated differently than the actual percentage rate of mortgage loan. Lets take a case scenario where a mortgage loan applicant applies for a 30 year fixed rate FHA loan of $200,000 at a 4.25% interest rate. The scheduled monthly payment will be $983.99. If we take two case scenarios where one is a mortgage loan applicant applies for a loan at Mortgage Company A for a loan amount of $200,000 with a 4.25% interest rate and the cost associated with the mortgage loan of $2,000, the APR is calculated by taking the original loan amount of $200,000, less the cost of the mortgage loan of $2,000 which yields $198,000. Let’s say both mortgage loan terms are 360 months and the monthly payment is $983.33. If we calculate the APR for this loan with Mortgage Company A, you take the net loan amount after deducting the cost of doing the loan, which is $198,000 amortize it over 360 months with a payment of $983.88 and run these figures in a mortgage calculator, the APR, annual percentage rate, will yield an APR of 4.33%. We will now take case scenario two where the mortgage loan applicant applies for the same type of loan, a $200,000 loan with a 4.25% 30 year fixed rate FHA loan of $200,000 with a payment of $983.99 with Mortgage Company B but the costs associated with doing the loan is $5,000 versus the $2,000 with Mortgage Company A. To calculate the annual percentage rate, APR, we need to take the original mortgage loan amount of $200,000 and deduct the cost associated with doing the mortgage loan, which in this case is $5,000, where it yields $195,000. This figure is derived by taking the $200,000 and deducting the $5,000 cost associated by Mortgage Company B which the $195,000 figure is derived. You then input the $195,000 loan amount, the $983.99 payment, the 360 month loan term (30 years fixed rate term ) into a mortgage calculator and you get a rate of 4.47% APR. The annual percentage rate, APR, is a form of giving a form of the cost associated with getting a mortgage loan in terms of an interest rate and that is what an APR, annual percentage rate is. It makes it easier for a mortgage loan applicant to shop the costs associated with a mortgage loan with a particular rate when shopping from one mortgage company to another.
Case Scenario On APR
We will now take another case scenario so our viewers can fully comprehend what an annual percentage rate, APR, is. Say a mortgage loan applicant gets a mortgage rate of 5.0% on a $200,000 30 year fixed rate loan with the monthly payment being $1,073.64 and the costs associated with doing this loan from Mortgage Company A is $2,000. To calculate this APR, we subtract the $2,000 from the $200,000 loan amount at the 5% interest rate over a 30 year term ( $200,000 minus $2,000 yields $198,000: input this figure in the loan amount in the mortgage calculator) with a payment of $1,073.64 and input these figures in a mortgage calculator and it yields an APR of 5.09%. The annual percentage rate on this case scenario with Mortgage Company A is 5.09%.
Now, on this second case scenario, our mortgage loan applicant goes to Mortgage Company B. Our mortgage applicant applies for the same loan amount of $200,000 but gets a 4.50% interest rate which is amortized over 30 years with a principal and interest payment of $1,013.37 per month. On the first case scenario, the monthly principal and interest payment was at $1,073.64. Lets assume the cost associated with doing the second case scenario, the 4.5% interest rate loan is $10,000 versus the $2,000 charged by Mortgage Company A on the first case scenario. If you input the second case scenario into a mortgage calculator; $1,013.77, 4.5% interest rate, 30 year term, and $190,000 loan amount ($200,000 loan minus the $10,000 cost), it will yield an interest rate of 4.95%. The 4.95% is the APR, annual percentage rate. Going with Mortgage Company B at a lower interest rate but 5 times the costs ($10,000 costs associated with doing the loan) , 4.95% APR, will yield a better APR than going with Mortgage Company B with the 5.0% interest rate of $2,000.
Should I Go With Mortgage Company Offering The Lowest APR?
Going with the lowest annual percentage rate is not always the best fit for a mortgage loan applicant unless the mortgage applicant is planning on staying with the mortgage loan for the entire 30 year term. Remember that the APR is the upfront costs associated with obtaining a mortgage loan which is in an interest rate form. If you are planning on selling your home in three to five years, it is most likely best to go with the lower costs associated with getting a loan even with the higher APR because the chances are that you will not recoup the more upfront costs on a short term payoff mortgage loan.