What is wrong with APR?

What is the difference between mortgage interest rate and APR?

When comparing mortgage loan options, you will see two percentages — the interest rate and the APR. The interest rate is the cost of the loan itself. The APR is the cost of the loan to you. Reading these definitions next to each other, the difference seems minimal. One, however, is more comprehensive to your understanding of a loan offer.  

Lenders determine interest rates based on a set of assumptions used to gauge how risky a loan is. The interest rates offered to you reflect how well you stack up to those assumptions, so you may see higher rates for lower credit scores or equity. APR incorporates the interest rate into a larger calculation that also includes the total cost of the loan (closing costs, points, etc.). It should never be lower than the interest rate.

Is APR reliable?

The whole point of APR, as opposed to simple interest rate, is to help you understand the true cost of a loan. The Consumer Financial Protection Bureau (CFPB) requires that an APR disclosed to an eligible mortgage applicant must be accurate within 1/8% on a fixed-rate and 1/4% on an adjustable-rate mortgage. This is just an example of a rule. There is extensive legal language and guidelines centered on APR.  

Lenders that do not follow the CFPB’s guidelines may be ineligible to close a loan and could be subject to penalty and/or fines. There are, however, some ways in which APR can be flawed or misleading when it comes to mortgage interest rates. Here are a few potential issues to keep in mind:

• It may not reflect your actual costs: APR includes many of the costs associated with a mortgage, but it may not include everything. Additionally, some lenders may exclude certain fees from the APR calculation, so it's important to carefully review and compare your loan estimates to confirm what's included.
• It may not account for different loan structures: Lenders calculate APR assuming a traditionally amortizing loan, where you will make fixed payments over the life of the loan. However, some mortgages have different structures, such as interest-only payments, which can make the APR calculation less meaningful.
• It doesn't consider other factors that may impact the cost of borrowing: APR focuses solely on costs associated with the mortgage itself, but there may be other factors that impact the overall cost of borrowing, such as the tax implications of mortgage interest deductions.
• It assumes a specific loan term: APR assumes that you'll keep the mortgage for the entire term, which may not be the case. If you plan to sell the home or refinance the mortgage before the end of the term, your actual costs could be different from what the APR suggests.

What if I’m not keeping the loan the full term.

This is where CapCenter offers its greatest benefit. We offer a true Zero Closing Cost loan which, for the purposes of this topic, means your APR will equal your interest rate. The benefit is that once you have the loan you don’t have to worry about holding it to full term. You can monitor the interest rates and take advantage any time the rate drops. In fact, we calculate that you may benefit from our Zero Closing Cost loan product with a refinance every 0.125% drop.  Lenders calculating APR assume you will hold a loan for the full term. If you don’t, the true APR goes up significantly because you already paid the up-front costs for the loan and will not get them back. Realistically, most people refinance their original loans. If you do not have to pay the up-front closing costs, you don’t lose the money when you refinance.

How can I get a better APR?

The interest rates a lender offers consider how risky — by their standards — it is to lend you money. One thing that can positively affect ‘riskiness’ is having a significant amount of equity in the home you are financing. This can mean paying a large down payment on a purchase or refinancing a property you’ve already built equity in. Lenders heavily consider your credit score when determining your interest rate. For more on credit score, click here.

If your credit profile is strong and you are eligible for the best rate, you can maximize your APR by finding a lender that covers all the extra costs associated with obtaining a mortgage. APR gives you an idea of the true cost of a loan. If there are no extra costs on top of a loan, the interest rate is the true cost of the loan. Find an example of this on the CapCenter refinance calculator. You’ll notice that on a standard refinance with no points, the interest rate and the APR are the same.

The bottom line

The intention behind APR is good. The goal is to give borrowers an accessible way to quickly compare loan offers. In practice, however, APR may not actually offer the transparency it is intended to provide.  

You should avoid making a final decision based just on APR. There are potential flaws in how a lender calculates or represents APR. CapCenter’s Zero Closing Cost loans adjust for these flaws and allow you to take full advantage of any lower rate at any time, without losing money.