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What is APR?

APR, or annual percentage rate, attempts to show the total cost of credit for a mortgage loan by combining the interest rate and closing costs into a single percentage rate. The intent behind APR is to make comparing loan offers much easier, but it’s often misleading at best.

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Is APR Useful for Shopping for a Mortgage?

APR, or annual percentage rate, attempts to show the total cost of credit for a mortgage loan by combining the interest rate and closing costs into a single percentage rate. The intent behind APR is to make comparing loan offers much easier, but it’s often misleading at best.

The reason APR can be misleading is because it amortizes the closing costs over the total term of the loan. In other words, it assumes you’ll keep the loan for the entire loan term – which almost never happens. Most people refinance or sell the home by the 7-year mark.



For example, if you have a 30-year loan and the closing costs are $5,000, APR assumes the total cost of credit is your interest rate plus $167/year for the closing costs ($5,000 in total closing costs/30 years).

But what if you only keep the loan for 7 years? In that case, your true cost of credit would be the interest rate plus the total closing costs divided by 7 years, which works out to be around $714/year.

As you can see, APR can be extremely inaccurate if you don’t keep the loan very long. This is why it’s usually better to just shop based on the actual rate and fees – not APR. Mortgage financing involves a tradeoff between closing costs and interest rate. In other words, if you want a lower rate, expect to pay more in closing costs. If you want lower costs, expect to pay a higher interest rate.

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A Good Rule of Thumb

This is a good rule of thumb: if you plan to keep the home for just a few years (maybe 5 to 7 years at most), it’s usually better to go with a higher interest rate and let the lender cover most (or all ) of your closing costs. If you know you’ll keep the home at least 7 years or more, it can make sense to pay more fees to get a lower rate, but don’t overdo it.

The lowest rate on the rate sheet isn’t necessarily the best deal.

Make sure to run such “buy down” scenarios through an amortization calculator so you can see how long it will take to make up for the added costs.

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How to Shop

Have a few lenders generate offers based on this rule of thumb. Make sure they do a complete application and run a credit report so they’re forced to disclose their offer, which makes it binding on them. Once you have a few offers, don’t compare APRs, compare the rates and fees themselves.

Pick out the offer that seems to offer the best balance of rate and fees, then have the other lenders update their offers with the exact same interest rate. Once you’re comparing offers with matching interest rates, it should be very easy to determine which lender has the most competitive offer.



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