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APR: What Is It? How Does It Affect Your Mortgage Loan?

Were all used to hearing the term Annual Percentage Rate (APR) applied to credit cards and car loans, but this term is also used with mortgage rates. The APR was meant to level the playing field, however, it gets confusing. The interest on a mortgage loan is the price you pay for borrowing money. Closing costs and all the other associated fees are the costs involved in the process of buying the home and getting the loan.

Its when you put these costs together to come up with an APR that people get confused , usually with good reason. The APR is the cost of a loan expressed in terms of an annual interest rate. With credit cards and car loans the APR is just that, the interest rate. With mortgages, however, the loan includes other loan-related costs, so the APR is invariably higher than the interest rate.

Further complicating the matter is the fact that the APR is based on the life of the loan -- usually 30 years. If you refinance, or sell early, or make additional payments to reduce your principal, the APR figure is pretty useless. As a result, the APR only gives you a general idea of how much you are paying for the loan in addition to the interest rate. Its biggest advantage is that it forces lenders to disclose all the fees that you will have to pay prior to signing final paperwork, and it also serves as a basis for comparing quotes from competing lenders.

Before we look at how an APR is actually computed, remember that there are two different ways that the fees you pay when buying a house and getting a mortgage are determined. Some are a percentage of the loan. Some arent. Appraisal fees, for example, will be the same regardless of the size of the loan. In this case it is the size and value of the home and the amount of time and work that an appraiser has to do that will determine the cost of the appraisal, not the size of the loan.

Other charges, such as the brokers fee, are usually a percentage of the loan. The APR normally includes the brokers charge, any loan origination charges, processing and underwriting fees, and discount points, which are a form of prepaid interest. Private Mortgage Insurance (MI) is also included. MI is required when a single loan exceeds more than 80 percent of the cost of the house. So if you get an $85,000 mortgage on a $100,000 house you will pay MI. With an $80,000 loan on the same house, you wont. MI can add hundreds of dollars a year to your monthly payments, maybe even thousands. On a side note, government-backed loans, such as FHA (Federal Housing Administration) and VA (Veterans Administration) loans, factor in FHA insurance and VA funding fees, which are similar to MI.

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