Annual percentage rate (APR) is a term commonly used by financial institutions that can sometimes be confusing. However, understanding APR is critical for anyone who wants to make informed decisions regarding real estate mortgage loans. That’s because the annual percentage rate is one of the most critical factors in determining the cost of a real estate loan. This number can impact your monthly payment and even affect the loan’s total cost.
After reading this article, you will better understand the annual percentage rate (APR) and what it means for you. We explain APR in easy-to-understand language, the difference between APR and APY (annual percentage yield), the different types of APRs, and provide examples so that you can see how this number impacts your bottom line.
What Is Annual Percentage Rate (APR) in Real Estate?
The annual percentage rate (APR) is the cost of credit expressed as a yearly interest rate. It compares the costs of different loans, such as mortgages and other real estate loans. The mortgage APR includes interest and other applicable fees that are part of the total cost of borrowing money. These charges can include closing costs, points paid for discounted rates, broker fees, and more.
Difference Between Interest Rate and APR
While related, there’s an important difference between interest rate and APR. An interest rate tells you how much it will cost you in interest alone over a certain period; it doesn’t factor in additional costs, such as those associated with PMI or closing costs.
On the other hand, an APR takes those additional costs into account, giving you a more accurate picture of your total interest amount for borrowing money over a given period. When shopping for a loan or mortgage, comparing APRs is important instead of just interest rates. This will give you an accurate picture of which lender offers the best deal based on your specific needs and circumstances.
An APR calculation should include all applicable fees associated with taking out a loan or mortgage from that particular lender, so you know exactly what you’re paying for each year going forward.
How APR Works
An example of the difference between APR and interest rate can be shown in an interest rate disclosure. For example, if a bank is offering a 30-year fixed-rate mortgage at 6.0%, the total cost of borrowing money for this loan could look something like this:
- Interest Rate: 6.0%
- Lender Credit: $675 toward closing costs
- Closing Costs/Origination Fee: $3,000
- Total Annual Percentage Rate (APR): 6.2%
In this case, while the annual rate is 6.0%, when considering all the fees associated with the loan, the annual percentage rate (APR) comes to 6.2%. This means that the borrower will pay a slightly higher rate than the initial interest rate. This example has a fixed APR, which ensures that you will be paying the same interest throughout your loan’s lifetime regardless of market fluctuations.
Variable APR and ARMs
A variable annual percentage rate (APR) indicates that the rate you will pay may differ over time in response to changes in market conditions. It is affected by the prime rate, the leading industry benchmark at any given point.
Credit card APRs, cash advances, and balance transfers are usually variable, while car loans and personal loans are often offered with fixed rates. Mortgages can also come with either fixed or variable rates depending on your credit score; generally speaking, higher scores lead to better rates.
An adjustable-rate mortgage (ARM) is a type of mortgage loan where the interest rate and introductory APR can change over time. This means that your payments may be subject to changes due to fluctuating market conditions. With an ARM, you will typically get a lower initial interest rate than a fixed-rate mortgage, but it carries some risk because the interest rate could go up or down at any time.
For example, assume a borrower has a 15-year adjustable-rate mortgage (ARM) with an initial 5.8% interest rate, pays one point, and has $2,000 in loan closing costs/origination fees. In this case, the total APR might be 5.9% at the beginning of the loan term. The length of time before the first adjustment period varies from loan to loan, but most ARMs adjust every 1-5 years.
A 5/1 ARM has a fixed interest rate for the first part of its term, in this case, five years. After that set period is up, the loan’s interest becomes variable for the rest of its repayment timeline, adjusting every year. ARMs usually have caps that limit how much the interest rate can increase and decrease so that borrowers know their maximum payment amount in advance.
Points and Lender Credits
Some lenders may also offer discounted rates or promotional programs which could affect the APR, such as paying points or accepting credit from the lender. As the Consumer Financial Protection Bureau (CFPB) explains, “Points, also known as discount points, lower your interest rate in exchange for paying an upfront fee. Lender credits lower your closing costs in exchange for accepting a higher interest rate.”
By understanding how each of the fees factor into the total cost of borrowing money, borrowers can more accurately compare different loans and make an informed decision on which one is right for them. This will ultimately help them save time and money in the long run. With detailed information regarding the APR, borrowers will be better equipped to budget appropriately and make responsible decisions about taking out a mortgage or other real estate loan.
APR vs. APY
The annual percentage yield (APY) is the measure of a loan’s yearly cost with any cumulative interest. Typically, APY will be higher than the annual percentage rate (APR), depending on how often compounding occurs. For simple interest loans, both APR and APY are equivalent. Compound interest can often be found in savings or deposit accounts which provide advantageous APYs.
An example of APY would be if you invested $1,000 in a savings account that had an APY rate of 3%. Every year, your interest would be calculated on the initial principal plus any accrued interest from the previous year. So after one year, you would have earned $30 in interest (3% of $1,000), and at the end of two years, you would have earned $60.90 ($30 + 3% of $1030).
This compounding effect makes APY valuable for those looking to grow their money over time and for a lender offering a borrower a loan with compounding interest. Compounding interest allows a lender to earn more money over time, as the interest earned on the loan is added back into the principal amount, increasing the total loan value.
What Does APR Tell Me?
By calculating the APR on a loan or mortgage, borrowers can find out what their true cost will be over the life of the loan based on current market conditions. For example, let’s say you’re looking at two 30-year fixed-rate mortgages with the same interest rate but different closing costs and fees. By looking at the APR, you’ll see which loan product is more expensive, even though they have the same interest rate. This makes it easier for potential buyers to make informed decisions about their real estate purchases by getting an in-depth view of all the associated costs.
What Doesn’t APR Tell Me?
While APR can give you an accurate picture of the total cost of a loan, it doesn’t tell you everything about your mortgage loan and how it works. For instance, APR doesn’t consider any additional costs associated with refinancing or prepayment penalties; these are important considerations when taking out a mortgage loan and should be discussed with your lender before signing any paperwork. Additionally, while a higher APR may help inform your decision when selecting a loan product, other factors, such as customer service and ease of use, should also play a role in your decision-making process when selecting a lender.
How APR Affects Mortgage Loan Decisions
Loan offers can be tricky if you don’t understand what goes into calculating an APR. Depending on things like credit score or down payment size, different lenders may offer very different terms on their loans, so it’s essential to make sure you compare apples-to-apples when comparing two different lenders’ terms.
However, because all lenders are required to prominently display their APR on their loan documents, doing so can help ensure that you get the best deal possible on your mortgage loan by enabling easy comparison between multiple offers.
Fortunately, when it comes to obtaining a loan, buyers don’t have to calculate their annual percentage rate on their own. As mandated by the Truth in Lending Act, lenders are required to offer individuals with a disclosure statement that contains specifics such as the APR, charges incurred, upcoming payments, and the total amount of money it will cost them should they keep the mortgage until its maturity date.
Tips for Getting a Lower APR
There are several key factors that can determine a borrower’s annual percentage rate (APR) when shopping for a loan. All lenders typically check an individual’s credit report as part of the underwriting process, which is an important factor in determining the interest rate. The higher the credit score, the better your chance of getting a lower interest rate and APR.
Furthermore, loan amounts, down payments, and loan type all have an impact on the actual rate. For instance, the more money put down on a loan, the less risk to the lender and thus helps lower rates. Additionally, location also plays a role in determining interest rates with some states being more expensive than others.
Lastly, the term of the loan and type of interest rates should also be taken into consideration when looking for the best APR rate possible – shorter-term loans usually have lower interest figures, while fixed-rate products give borrowers the same monthly mortgage payment than adjustable.
Closing thoughts on APR
Knowing how the annual percentage rate works when considering a real estate mortgage loan can help buyers make an informed decision about which lender has the most competitive offer overall. Comparing APRs—rather than just interest rates—will ensure that buyers get a complete picture of all applicable fees associated with taking out a loan from each particular lender they are considering using for their financing needs. Understanding all aspects of your mortgage loan is key to making sure you’re getting the best deal possible on your purchase.
With so many real estate investment options on the market, it can be tough to know where to put your money. At Arrived, we take care of the heavy lifting for you by searching and managing properties so you can sit back and reap the potential rewards. Browse available properties today and see how your initial investment could grow over the next few years.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice. View Arrived’s disclaimers.
