Here’s What Mortgage Interest Rates Don’t Tell You
It’s a common misconception that when obtaining a mortgage, the interest rate is the best way to gauge the cost to the homebuyer. While it is indeed useful to know how much you would be paying every month for your new home, interest rates actually do not give you the complete picture – they fail to account for all of the fees that come along with obtaining your loan. When shopping for a mortgage, only the annual percentage rate (APR) offers full disclosure of the costs required to obtain a mortgage. It is the best way to accurately comparison shop between mortgage lenders.
Under the Truth in Lending Act (TILA), lenders are required to disclose the APR to borrowers, so it should be easy to find it when you are comparing lenders. The TILA is meant to protect borrowers like you against inaccurate and unfair credit billing practices. In other words, the APR is meant to be your friend – use it!
APR = Interest Rate + Amortized Fees
The amount of fees required to obtain a mortgage can be surprising to some buyers. The APR accounts for these fees and combines them with the interest rate to clearly communicate to buyers what the cost of the mortgage is. So instead of a lender telling you that the interest rate is 3.5% with $5,000 in fees, they can just say that the APR is 3.67%. While the fees may vary by lender, here are some examples of the different types that can be included:
- Origination Fee – covers the loan officer’s commission.
- Application Fee – not every bank requires this.
- Processing Fee – covers the cost of the loan processor’s work to double-check the paperwork.
- Underwriting Fee – covers cost of having an underwriter approve, suspend, or decline the application.
- Appraisal Fee – covers the cost of property value appraisal.
- Mortgage Points – buyers can choose to prepay interest at the time of closing in exchange for a lower interest rate.
These fees are usually included in the APR, but be sure to check carefully with each potential lender about what fees they charge – there are others they may require. It is worth noting that APR calculations are based on fixed interest rates, so adjustable rates create ever-changing APRs. It is also important that a borrower compare loans with identical maturities (or length of time over which the mortgage is to be paid). A shorter loan could have a lower interest rate but a higher APR because the loan fees amortize over a shorter period of time. Lastly, be prepared to pay for the fees upfront at the time of closing.
Mortgage shopping typically isn’t the buyer’s favorite part of purchasing a new home because it can be monotonous or even stressful to some. But in the end it’s a big step towards the most exciting day of the process: closing day. By doing your research and staying informed, you can help ensure that the process of obtaining a mortgage goes smoothly and ends with you getting the deal you want.
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