July 19th, 2016 12:28 PM by Robin Bain
Can You Trust APR
As A Rate Shopping Tool?
You see it almost
daily when you’re shopping for mortgage rates look at the annual percentage
rate (APR) to find the “best deal” on your mortgage.
The articles and
news reports say to get multiple rate quotes and choose the one with the lowest
That could be a
bad idea. The loan with the lowest APR could be far and away the most
What Is APR?
APR is a
calculation created by the government to make it "easier" to compare
loans with different combinations of interest rate and fees.
Unlike the stated
interest rate, the APR incorporates both the interest and the loan costs.
For instance, a
loan offer might come with a 3.75 percent interest rate and a 3.95 APR.
zero-closing-cost mortgage has the same rate and APR. If you borrow $100,000 at
a 4.0 percent interest rate, and there are no other costs, your APR is also 4.0
When you pay loan
fees yourself, your APR rises.
examples show how loan costs affect the APR on a mortgage of $100,000.
The 3.5 percent
rate comes with the lowest APR. But if you choose this option, you’ll probably
pay too much for your home loan. Here's why.
Are Often Untrue
The problem with
APR is that it only "works" if several assumptions hold true.
calculation breaks down if you refinance in five years, for instance, or you
compare a 30-year fixed mortgage with a 5-year adjustable rate loan.
Suppose you choose
the 3.50 percent loan because it has the lowest APR.
You pay $5,000
upfront, and in exchange, you pay $28 a month less.
payments over the life of the loan will be about ten thousand dollars less than
they would if you paid nothing upfront and took a 4.0 percent loan.
That’s a savings
of $5,000, which proves that the loan with the lowest APR was indeed the best
If, however, you
sell your home after just five years (60 payments), you’ll have paid $5,000
upfront to save just $1,680. That’s a net loss of more than three thousand
So the “best” loan
did not save you money; it actually cost you money. And that’s not even
considering all the other things you might have done with that $5,000, like
paying off credit cards or building your retirement fund.
APR Confusion For
Short Loan Terms
monkey wrench, brought to you by APR.
demonstrates what happens to the APR when changing the loan term from 30 years
to 15 years.
The costs for the
15-year loan are the same compared to the 30-year one, but the APR is
higher. Still, you pay thousands less in interest for a 15-year loan term.
consumer might pick a 30-year loan, mistakenly thinking they are saving money.
Lenders don’t all
calculate the APR exactly the same way.
Some include the
credit report fee, for instance, and some don’t.
are minor, but could be enough to convince you to choose one lender over
another. Both lenders could charge the exact same amount in real dollars.
When you receive
lender disclosures, compare fee for fee, line by line. Don't rely on the
"easy" way of comparing the APR by itself.
You Can Do Better
factors to you, the mortgage consumer, are the loan’s interest rate and costs.
A Department of
Housing and Urban Development (HUD) study of FHA closing costs discovered
something interesting. FHA borrowers who shopped “zero-cost” deals were
more successful because all the confusing elements were taken off the table.
A zero-cost loan
is one in which the lender issues a slightly higher interest rate in exchange
for paying all closing costs.
compared rate only, and didn’t try to work out which lender charged the least
This could be a
good strategy for home buyers and refinancing households that simply want the
bottom-line “best deal” on their mortgage.
What Are Today’s
Mortgage rates are
hitting 3-year lows, and there have been few better times in history in which
to shop around for a good rate.
Get a quote for
your home purchase or refinance.