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Understanding Interest Rates and Annual Percentage Rate

 

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Understanding Interest Rates and Annual Percentage Rate

June 08, 2020

Applying for and understanding mortgage loans can be a very confusing process for anyone.  The terms, the lingo, and the paperwork can become very overwhelming very quickly, and the confusion often leads to misunderstanding important terms in the application process.   There are two terms in particular that are used and referred to throughout the entire process, from the loan application review to the closing, and those terms are Interest Rate and Annual Percentage Rate (APR).  Since these two words refer to the amount of money you will be responsible for paying, it is extremely important to know the difference between the two and how they relate to your mortgage payments.

Let’s begin with the interest rate, sometimes referred to as the note rate.

The interest rate is the cost, or amount of interest, you are paying on the principal loan amount that is borrowed.  The interest rate will always be expressed as a percentage, and it is basically the percentage of principal the lender is charging you to use their money for your purchase.  The interest rate is determined by a number of factors including your credit score, current market conditions, the loan type and term, loan amount and down-payment amount.  When a lender advertises a low interest rate, do not assume that lender is going to offer you the best deal.  Since there are always other fees associated with purchasing a home, you need to also consider the annual percentage rate.apr

The annual percentage rate, though often confused for interest rate, is much different.

The annual percentage rate shows you the overall big picture.  It is the cost that encompasses not just the interest rate, but also the closing costs, broker fees, discount points and rebates included in the transaction.   The annual percentage rate is used to determine the total cost of your loan with all fees included.

When shopping for loans and working with various lenders to determine what loan is right for you, it is important to know that all lenders need to disclose both the interest rate and the annual percentage rate in their offers.  Many borrowers request their interest rate and use only that rate to compare mortgage offers, however the interest rate will only allow you to determine what your monthly costs are, but will not paint the overall picture of your loan amount including the principal, interest rate, closing fees, etc. 

When shopping for a mortgage it is also important to factor in how long you plan on staying in that particular home.  Do you plan on staying through retirement, through the term length of the loan?  Or is this home just a starter home and you plan on moving on in the next few years to something bigger?  Its important to keep this in mind since you certainly want a low annual percentage rate if you are staying in the home and paying on that loan long term as you will pay less overall to finance the home, however if you plan to refinance or move in the near future, you can consider paying fewer fees upfront and paying a higher rate (and annual percentage rate) because the total costs that you pay in those first few years could be less.  Yes, this is confusing, but remember that the annual percentage rate that you pay is spread over the entire length of the loan, benefiting the owner on a long-term basis.

Determining the best option for you and your particular circumstances can be very confusing.  You want to be sure you are getting the overall best price while fully understanding what fees are involved and the long-term implications.  Always be sure to ask your lender questions, and ask them over and over if needed, in order to fully understand the terms of theNew Call-to-action being offered to you.

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