Lenders are going to show you multiple numbers when they give you a quote—the interest rate, the APR, the points (or costs for points), and fees. Holding all these numbers inside your head is kind of bonkers, and not everyone wants to write formulas in Excel sheets to figure out the pricing, so a lot of agents and other professionals try to keep it simple—just look at the APR, they say.
But should they? Is that the best apples-to-apples way to compare pricing? We’re going to break it down for you.
First off, what exactly is the APR?
APR, or Annual Percentage Rate, represents the total yearly cost of borrowing, including interest and fees. It’s a percentage that gives you a clear picture of how much you’ll be paying each year on your loan. APR is a handy tool for comparing loan offers because it consolidates various costs into one number, making it easier to see which loan might be cheaper in the long run.
| Fees and Charges | Interest Rate | APR |
| Interest on the Loan | Yes | Yes |
| Loan Origination Fees | No | Yes |
| Underwriting Fees | No | Yes |
| Mortgage Points | No | Yes |
| Mortgage Insurance Premiums | No | Yes |
| Other Closing Costs | No | Yes |
Is APR the best way to evaluate different loans?
Not exactly. There are several limitations to keep in mind:
| Factor | Explanation | Example | Impact on Long-Term vs Short-Term Costs |
| Differing ways of calculations | Lenders may include/exclude different fees in the APR calculation, leading to discrepancies. | Lender A includes underwriting fees in their APR, while Lender B doesn’t. This makes Lender A’s APR seem higher, even though both loans have similar overall costs. | Short-term: Might make a loan seem cheaper initially. Long-term: Can result in higher actual costs if fees are excluded. |
| Assumes Full Loan Term | APR assumes you will keep the mortgage for its entire term, which may not be true for most buyers who refinance or sell. | Loan A has a 30-year term with upfront points but you plan to sell in 5 years, making the APR less useful. | Short-term: APR might seem higher, but refinancing or selling early can avoid the long-term costs. Long-term: APR overstates the cost. |
| Impact of Upfront Costs | Paying points (prepaid interest) or fees can make the APR seem higher than it will be over the life of the loan. | Loan C has 2 points ($4,000) but a lower interest rate, leading to higher APR but lower long-term costs. | Short-term: APR seems higher due to upfront points and if you don’t plan to hang onto the loan for a long time this should be of interest. Long-term: Lower monthly payments and interest lead to better long-term savings, so if this is your forever home . |
How should borrowers use APR when evaluating loan offers?
Borrowers should use APR as a baseline. If you are new to home buying, or quickly reviewing offerings, APR is a great, comprehensive starting point and will give you a more accurate portrayal of your loan cost than the interest rate alone.
What else should borrowers factor in when shopping for loans, in addition to APR?
While APR is a useful tool for comparing loans, it shouldn’t be your sole deciding factor. It’s important to consider other aspects of the loan, such as:
- Fees and Costs: Look beyond the APR to understand all associated fees and costs.
- Your Loan Duration: Consider how long you plan to keep the loan. If you’re planning to move or refinance before the loan term ends, the APR might not fully reflect your actual costs.
What’s the bottom line?
APR is a key metric for comparing loan offers and understanding the yearly cost of borrowing, but it’s not the whole story. It doesn’t cover every cost or factor. To make the smartest choice, start with APR, but dive deeper into other loan details and your own financial situation. This approach ensures you pick a loan that truly fits your needs and goals.
If you’re ready to start your journey to homeownership, get pre approved with Tomo Mortgage today.