Why is my mortgage’s APR higher than my mortgage’s Interest Rate?

(This information relates to fixed rate loans only.  The APR for Adjustable Rate Loans is not very useful because no one knows what the rate will be for all of the years after annual adjustments begin)

You should look at both Interest Rate and APR when making a decision about which mortgage is right for you.   Most shoppers focus solely on interest rate, but your interest rate doesn’t tell the whole story.

Without looking at APR, you might see a very low interest rate that appears too good to be true, because it is coupled with many thousands of dollars of hidden fees.  Kinsey and I recently did an analysis for a client who had an extremely low interest rate quote.  Upon closer inspection, we found $19,000 in APR fees.

What’s an interest rate?
Your actual interest rate is the baseline cost to borrow the money.   Your Interest Rate, the Loan Amount you borrowed, and the Term of the loan are used in a mathematical formula that calculates a monthly payment that over the life of the loan (loan term) pays the principal balance of the loan down to $0.   For Example:

Amount Borrowed: $350,000
Fixed Rate Loan Term in Years: 30
Total Number of Payments: 360
Fixed Interest Rate: 6.375%
Monthly Principal and Interest Payment: $2183.54

What we see here is that with a 6.375% interest rate, over 360 payments, a monthly principal and interest payment of $2183.54 pays the original $350,000 loan balance down to $0.  That’s it.

What is APR?
Your mortgage’s Annual Percentage Rate (APR) starts with your interest rate and then adds to it the upfront and recurring costs associated with borrowing money, giving you the true total yearly cost of the loan, over the life of the loan.   In a nutshell, your APR shows that you are paying money to borrow your loan amount, costs that are above and beyond the interest rate.

These upfront and recurring costs are called Prepaid Finance Charges (PFC).  They are loan related closing costs that you would NOT pay if you were paying cash to buy home.  The APR calculation will vary by lender, so it is best to ask your loan officer directly for a breakdown of what goes into his or her quoted APR.

Here are some examples of Prepaid Finance Charges (PFC):

1. FHA Up Front Mortgage Insurance Premium
2. VA Funding Fee
3. Single Premium Mortgage Insurance
4. Monthly Mortgage Insurance Payments
5. Discount Points
6. Origination Fee
7. Commitment Fee
8. Lender Fee
9. Underwriting/Processing fees
10. Flood Certification
11. Condo Docs Fee
12. Closing Attorney Fee
13. eRecording Fee
14. Prepaid Daily Interest

It is important to note that the wider the gap between your interest rate and your APR, the higher your borrowing costs over the full term of the loan.

Why the Difference Matters

• Interest Rate: Determines your actual monthly payment.

• The APR (Annual Percentage Rate) is higher than your base interest rate because it represents the total yearly cost of borrowing, and gives you a comprehensive view of your loan’s cost, over the full term of the loan.

Without looking at APR, you might see a very low interest rate, which appears too good to be true, because it is coupled with many thousands of dollars of hidden fees.

Is a lower APR always better?  Not necessarily.    To benefit from an Interest Rate with a lower APR vs. the same Interest Rate with a higher APR, you would need to keep the loan for the full original term of the loan.

Reality Check & the Frank Rexford Mortgage Team Difference

Nobody keeps a 30 year fixed rate mortgage for 30 years.  Rates fall and people refinance.  Families grow and a bigger home is needed.  Job changes cause a need to relocate.  Kids move out, leaving an empty nest.  People retire, and then downsize.  It is hard to find an actual statistic, but for these reasons and more, the average life of a mortgage probably falls between 7 and 10 years.

For this reason, when Kinsey and I quote rate offers for our clients, we show Interest Rate, APR – and a detailed cost comparison over the 1st 10 years of the loan.  We want to help you make an intelligently evaluated decision based on your family’s needs and timeline!  Shown here is a snippet of some key points from our 2 page Loan Summary.  We’d love to prepare one for you!

We make this comparison because it can take years to begin to benefit from paying points for a lower rate, despite having a lower APR.

Note: the cancellation point for monthly mortgage insurance is not included in these calculations.