When you see a loan rate advertised, you’ll also see a corresponding APR (for example 4.5%/4.762% APR). This Annual Percentage Rate is the total cost of your loan (interest and fees) expressed as a single number. The purpose is to give you one number for comparing multiple loans.
But it’s an imperfect science…The problem with using APR as designed is that the calculation applies to the entire length of the loan, and most people use mortgage loans for only a few years due to refinancing or sale.
So be careful with your comparisons…Using APR for comparison can become misleading. Below, you can see the low APR option would cost over $1,500 extra if used only three years. In the fifth year, the lower APR begins to pay off with a savings of a little over $500.
Here’s a quick tip…The bigger the difference between the rate and the APR, the higher the fees. This is handy information to use when you see a really low rate advertised. The APR can be 2 percent higher or more depending on your closing costs and fees.
Another way of looking at this example is to ask yourself whether you prefer $3,000 of savings in the bank or a payment that’s $30 less per month. If you are more comfortable with money in the bank, lean toward lower upfront costs. If you are more comfortable with the lowest possible payment and believe you’ll use the loan for five years or more, then the lower APR alternatives start to make sense.
Bottom Line…Lenders are required to disclose APR; we provide this extra information so you can make a truly informed decision about what’s right for you. You should always work with a lender who will give you a total cost analysis which includes your exit strategy (pay off, refinance, move or stay) and your long term and short term costs and savings.
If you’re interested in getting a total cost analysis either on your existing home loan or for a future purchase of a home just click the button below.
Example shown is based on a fixed rate home loan on a 30 year term.