The costs associated with obtaining a home loan are difficult for many consumers to understand. This is not only because of the many acronyms used by people in the real estate business, but it is also due to the fact that there are so many different closing costs. Mortgage interest rate and APR are two important yet different numbers to look at and analyze in order to decide if a loan is right for you.
Interest Rate
The real estate website Zillow.com states that the interest rate of a loan is the percentage of the loan amount that the borrower must pay back in addition to the borrowed money. Interest is a fee for borrowing and using the money. The interest rate of a mortgage affects monthly payments. For instance, a $200,000 loan with a 5% fixed interest rate and a 30 year repayment term would have a monthly payment of about $1073, some of which would go towards paying down principal and some of which would pay interest.
What's Included in APR?
According to Lending Tree, the APR, also called annual percentage rate, is the total cost of obtaining a loan, including all fees charged over the life of the loan. Annual percentage rate is expressed as a percentage, and includes a loan's interest rate, as well as monthly payments for impound accounts, homeowner's insurance and other costs.
Determining the Better Loan
Both APR and interest rate are ways to analyze the long-term costs associated with a mortgage. They both need to be considered by the borrower. Lending Tree explains that just because the interest rate is lower on one loan does not mean it is the better loan. For instance, a loan with an interest rate of 6.5% may actually cost more in the long run than a loan with an interest rate of 6.4%, because of discount points, origination fees and closing costs.
Truth in Lending Act
The Truth in Lending Act is an important piece of legislation which requires lenders to display the APR on every advertisement for a loan. The purpose for the Truth in Lending Act is to protect consumers by educating them to the true costs of obtaining a loan. This is also important for lenders because if people don't understand all of the costs associated with the loan, they may not be able to afford as much of a loan as they think they can afford. If a borrower borrows more money than he can afford to make payments on his house, he may need to be foreclosed upon.
Limitations to APR
While the annual percentage rate of a loan generally offers a wider view of the costs associated with a loan than just the interest rate, the APR does have some limitations. Lending Tree explains that APR is much more accurate when used to analyze fixed-interest rate loans. For variable or adjustable interest rate mortgages, APR does not take into account when the interest rate will adjust or how much the new cost will be. The APR also does not include the costs of home appraises, credit reports and title fees.
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