Finding the ideal interest rate and annual percentage rate (APR) on a home loan can seem like playing the old pea and shell game at the carnival. Except this time, the stakes can add up to thousands of dollars on a mortgage depending on the term of the mortgage and time the homeowner stays in the house. In fact, both the APR and interest rates consumers receive in offers from lenders should be evaluated down to the small print to find the best deal that matches the borrower's financial outlook.
Let's start with the simple part and define the two major costs involved in taking out a mortgage:
Mortgage Rate Explained
The interest rate is expressed in percentage points. It may be a fixed or variable. The estimate only identifies the rate. It does not contain charges that may be rolled into the total cost of the loan. A borrower seeking a lower monthly payment should pay attention to interest rates when shopping for a loan.
As part of the federal Truth-in-Lending Act (TILA), mortgage lenders are required to identify the Annual Percentage Rate whenever an interest rate is offered. However, lenders are not required to report all the charges rolled into the mortgage. By law, the APR must include the finance charge, the amount financed, brokerage fees, points and the schedule for paying back the loan. If the borrower is more concerned about the total cost of the loan, they will need to explore the details of the APR.
A Cautionary Tale about APR
According to the Consumer Financial Protection Bureau, federal rules govern the limit that lenders can charge on fees and still offer a "qualified mortgage". But there are no caps on the fees themselves. Lenders are subsequently allowed to add fees as they see fit for the mortgage package they're offering. Consumers should request a Good Faith Estimate (GFE) from each lender that details all the costs associated with the mortgage. The closing statement should also include the list of fees and should be examined carefully.
One way to think of APR is that it includes costs added on top of the amount financed. As a result, the APR is higher than the interest rate, and the interest is charged on the full amount of the loan plus all other costs. A low interest rate and hefty APR can blur the distinction between the benefits, particularly if the homeowner expects to sell the home and move before the loan is repaid.
Types of Fees
The APR may include origination, appraisals, processing, underwriting and document fees. Other charges can be assessed for notary, title insurance, attorney fees, and credit history reviews. If mortgage insurance is required, the consumer may save money by purchasing it on their own. In cases where the borrower agrees to pay points to reduce the interest rate, those charges must also be included in the offer or GFE.
Comparing Offers by Mortgage Rate and APR
LendingTree's LoanExplorer assists consumers in making informed decisions on mortgages. In the Good Faith Estimate details in the explorer, lenders send APR and payment estimates, including charges for mortgage insurance. Completed offers may show flexibility in fees, insurance and closing costs.