Before you actually get a loan of any kind, especially a mortgage or home loan, it is important that you carefully consider what kind of interest you are going to pay. To know for sure, you need to know the APR. What is APR? The APR, or annual percentage rate, determines just how much you pay overall for the privilege of borrowing money. On a long term loan, such as a 30 year mortgage, the difference of even one percent – or less, will most likely be measured in tens of thousands of dollars.
Although it may surprise you, the APR does not actually give you the exact amount of interest you will pay in a given year. Investopedia says that the APR only gives you the amount of interest paid on what you actually borrowed. It does not include any compounding of the interest or any fees associated with the loan.
A more accurate figure for the exact amount of interest on your loan will be understood by looking at the APY, or the annual percentage yield. The difference in how much you pay could easily be seen with a credit card. If the interest rate is 12%, says Investopedia, then you will pay that amount in interest if there is no previous balance and if it is paid in full when the bill is due. If, however, there is a previous balance and it is kept on there all year, you will most likely end up paying as much as 12.68% – the APY.
When it comes to an APR on a mortgage, the difference between the interest rate and the APR can mean you are going to pay a lot more money. When you see the interest rate for an advertised mortgage rate, be sure to look at the APR next to it. This is the more important number, and it is the number you want to look at when you compare mortgage loan offers.
Lending Tree mentions that just because one APR is lower than another one, it still may not mean that it is the best deal around. This is because the costs of a mortgage are normally spread out over the lifetime of the loan. If a 30-year loan costs $3,500, and you spread that cost over a 30-year period, that is not bad. But if you take the same loan, and now seek to pay the $3,500 costs in a much shorter time period, such as five years, this raises the interest rate much higher – simply because there is less time to pay the same amount of costs.
When considering a mortgage or other loan, it is important to look at the overall cost of the loan – not the monthly payment, says Janet Kincaid, who is the Senior Consumer Affairs Officer for the FDIC. Lenders often try to get the borrower to consider the monthly payment, and will often ask them how much they can afford – which gets your eyes off of looking at the overall cost. This may cause you to overlook various fees, service charges, or other conditions that may apply. In addition, if you put the cost of closing on the mortgage – rather than paying out of pocket – you will be paying that much more in interest.