When you are shopping for a home loan you will usually see rates quoted in two columns. The first will say INTEREST RATE and the second will say APR - which stands for Annual Percentage Rate.
What's up with that? Shouldn't the interest rate BE the Annual Percentage Rate? In a perfect world it would seem so - but, alas it is not.
The challenge is that this is one of those questions where if not explained simply, the answer can seem more confusing than the question. At the end of the day, I really believe that it's one of those great mysteries of life that "they" will never share with us - the regular people.
I do not claim to understand all the math but what I can do is explain to you the theory behind why there are two figures and how you can look at both numbers in a way that can help you make a decision about where to get your mortgage.
INTEREST RATE
This is the percentage that is used to calculate your monthly mortgage payments. So if you have a $250,000 mortgage and a rate of 5%, - the annual interest will be 5% of $250,000 or $12,500.
The $12,500 is then divided by 12 to determine the amount of interest you'll be paying monthly - about $1040.
The monthly interest payment will be added to the monthly principal payment to complete the calculation of your mortgage payment. There will likely be taxes and insurance added to that but that is not money that ultimately goes to your lender so it is not relevant for this discussion.
ANNUAL PERCENTAGE RATE
This is the "Cost " of your mortgage calculated as an annual figure. It includes not only the interest, but also points and some of your closing costs. So it will be likely always be higher than the interest rate This number is the true cost of your loan.
SO - WHY DO I CARE AND HOW DO I USE THIS INFORMATION?
What you need to look for when comparing loans is the "spread" between the two figures.
LOAN #1: 5% Interest Rate with an APR of 5.25%
LOAN #2 5% Interest Rate with an APR of 5.65%
In Loan 1 the spread is .25% In Loan 2 the spread is .65% Loan two is a more expensive loan.
DOES THIS MEAN I CHOOSE LENDER 1?
There are many different factors you may use when choosing a lender. This is just one of them. It's one of my general life rules that the least expensive product does not make it the best. Understanding what something is costing you, though is critical.
