The Hidden Truth in Your Mortgage APR (And Why It Matters)

Most buyers take out a mortgage when buying a home, which can sometimes mean paying more in total mortgage costs than the actual home sale price. As such, it’s crucial to compare mortgage loan offers because even small differences can add up significantly. 

While interest rates might be the headline number, the annual percentage rate (APR) could provide a fuller picture of financing costs, so borrowers should carefully analyze this metric.

A high APR isn’t necessarily always a negative, as it could mean certain costs are rolled into the mortgage rather than paid upfront, but APR can still be an important indicator of mortgage affordability.

What Is APR?

An APR reflects full financing costs, such as the mortgage interest rate plus additional costs such as lender fees and points, amortized over the life of the loan. For example, a loan with a 7% interest rate might have a 7.1% APR after accounting for the mortgage origination fee.

Lenders must disclose your APR, as required by the Truth in Lending Act (TILA). If you see your APR is much higher than your interest rate, that indicates various fees are driving up your total borrowing costs.

What’s Included in the APR?

A mortgage APR includes the interest rate plus other financing costs such as:

Note that there can be some gray area, particularly with third-party fees. Under the TILA, the APR is supposed to include any fees that are required by the lender as part of that loan, such as if a bank requires the use of a particular title company.

However, housing-related costs that are clearly not tied to a particular mortgage, such as property taxes and homeowners insurance, are not included in APR.

Why APR Matters When Comparing Loan Offers

By looking at APRs, you can compare the true cost of different loans. If two lenders offer the same interest rate, but one has much higher closing costs, then the APR would reflect that.

That said, you shouldn’t assume a lower APR is always better, and you should examine what’s underneath a given APR.

For example, you can pay money upfront to obtain a lower interest rate, known as buying points. That cost gets reflected in the APR, but there’s a big difference between, say, an APR of 7% that requires paying $10,000 to buy points versus an APR of 7% that does not require upfront costs. 

Common Misunderstandings About APR

Knowing a mortgage’s APR is important, but watch out for common misunderstandings.

For one, trying to compare fixed-rate and adjustable-rate mortgages (ARMs) can be difficult using APRs, considering lenders have to make assumptions about future interest rates for ARMs, which can make their APRs inaccurate.

Another issue is that APRs reflect costs over the full loan term. However, many borrowers end the loan early, such as by refinancing or selling. 

As such, you might mistake a low APR as being better, yet if that low number came from buying points and you only hold the loan for a few years, it might not have been worth paying those higher upfront costs.

How to Use APR When Shopping for a Mortgage

When shopping for a mortgage, be sure to look at interest rates and APRs together so you can see if the full financing costs are much higher than the interest rate suggests. You can also compare APRs from different lenders to get a better sense of what’s the most affordable, but don’t forget that different loan types and situations can affect whether a lower APR is better or not.

By taking into account additional factors such as the loan term and how long you plan to keep your mortgage, you can get a better idea of whether a particular loan’s APR seems like a good deal for your situation.

At the very least, APRs can clue you into how mortgages come with more costs than just the interest rate.

The Bottom Line

APRs are not the only thing to consider when shopping for mortgages, but they play a large role in what differentiates loans. Consider consulting with a financial advisor or lender for more about how to consider APRs with your specific situation.