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What Is Annual Percentage Rate (APR) And How Does It Work In Real Estate?

February 29, 2024 8-minute read

Author: Dan Rafter

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Looking for the most affordable mortgage loan? When shopping with lenders, you might focus only on the interest rates that each quotes. That seems logical: The larger your interest rate, the larger your monthly mortgage payment.

But there is a more accurate measure of your mortgage’s true cost, its annual percentage rate, also known as its APR. When shopping for the most affordable mortgage loan, it’s more important to look at this figure

What Is APR?

APR provides the best measure of how much borrowers pay for mortgage loans each year. It's an even more effective way of measuring your loan's annual cost than its interest rate.

Why? Because your APR does not just include how much you’ll pay in interest for your mortgage. It also includes several other fees, to give you the total cost – not just the amount of interest you’ll pay – of your loan.

What dos APR include?

  • Base interest rate: Your lender will charge you interest on the money that you borrow and will use that interest rate when calculating your monthly payments. The higher your rate, the higher your monthly payments. If your interest rate is 7.2%, you'll pay more each month than if your rate was 6.5%.
  • Document preparation fees: Your lender usually charges fees for preparing the documents that you'll sign during your loan's closing. This cost is included in your mortgage’s APR.
  • Underwriting fees: Underwriting fees cover the costs of the research that your lender's underwriters perform when determining if you’re willing and able to cover your new mortgage payment. Underwriters will review your credit score, bank statements, W-2s and paycheck stubs to verify your income and history with paying your bills.
  • Origination fee: Your APR also includes the origination fee you'll pay to your lender for the work it does while originating your mortgage. Because APR includes this and other fees, it is always higher than your loan's interest rate.
  • Closing costs: Closing costs include all the fees that you pay to your mortgage lender and the third-party providers -- including title insurers, real estate attorneys, inspectors and appraisers -- that work on drafting your new mortgage.

APR Vs. Interest Rate

The biggest difference between your loan’s APR and interest rate is that the APR includes both its interest rate and any fees that your lender and other providers charge while originating your mortgage.

Because your APR also includes lender fees, it will always be higher than your mortgage’s interest rate, providing a more accurate view of how much your mortgage costs.

APR Vs. APY

You might hear the terms APR and APY. But don’t get confused, these are not the same.

APY stands for Annual Percentage Yield, and instead of measuring how much you'll spend each year on a loan, it measures how much money you will earn each year from interest on an investment. Maybe you've invested money in a CD, money market account or high-yield savings account. The APY on these investment channels states how much you'll earn on them in a year.

How much you'll earn depends on several factors, including an account's balance, interest rate and how often its interest compounds during the year.

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How Does APR Work?

Want the lowest possible APR on your mortgage? Here are some of the factors that determine how high or low your APR will be, and the steps you can take to lower the one attached to your loan:

  • Credit score: Your three-digit credit score is a snapshot of how well you’ve paid your bills and managed your credit. The higher this score, the more likely you are to qualify for a lower interest rate and APR. Fortunately, improving your credit score isn’t as complicated as you may think: Pay your bills on time each month, especially those reported to the national credit bureaus of Equifax™, TransUnion® and Experian®. These may include your mortgage, student, personal and auto loan payments and credit card payments. And pay off as much of your credit card debt as you can.
  • Debt-to-income ratio: Your debt-to-income ratio (DTI) is another key factor in determining your loan’s APR. Most lenders prefer that your total monthly debts, including your new mortgage payment, equal no more than 43% of your gross monthly income, though some mortgages allow your DTI to go as high as 50%. You are more likely to qualify for a loan with a lower interest rate – and lower APR – if you have a low DTI.
  • Prime rate: The prime rate is the interest rate that banks and other lenders use as a base point when setting the interest rates they charge on mortgages, auto loans, credit cards and other forms of debt. When the prime rate is higher, banks and lenders will usually charge higher interest rates on mortgages and other loans. And when banks are charging higher interest rates, your mortgage’s APR will be higher. It can vary by bank, but most banks set their prime rate by adding about 3% to the current Federal Reserve Board’s federal funds rate. You can’t do anything about the prime rate, but you can take steps to make sure that your credit score and DTI are as attractive as possible, making it more likely that lenders will reward you with a lower interest rate even if the prime rate is higher.

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What Are The Different Types Of APR?

You’ll encounter three main types of APR when borrowing money or applying for a credit card.

Variable

A mortgage or loan with a variable APR comes with an interest rate that can change over time, rising or falling according to whatever economic index the loan is tied to. A mortgage with a variable APR, better known as an adjustable-rate mortgage, typically starts with an interest rate that is lower than what you’d get with a traditional fixed-rate loan. After a certain number of years, usually 5 or 7, the loan enters its adjustable period. During this time its interest rate will change, typically rising or falling once every year.

Fixed

A mortgage or other loan with a fixed APR comes with an interest rate that doesn’t change. The interest rate on your 30-year or 15-year fixed-rate mortgage will remain the same from the first day of your loan all the way to its last.

Credit Card

Unlike with loans, the APR and interest rate for credit cards is the same number. That’s because credit card providers don’t charge closing costs or fees when approving you for a credit card account. If your credit card comes with an interest rate of 25%, your card’s APR will also be 25%.

It isn’t that simple, though: Credit card providers offer several types of APRs that you need to be aware of.

  • Promotional APRs: Your APR might be lower when you first open your credit card account. Maybe your APR on new purchases is 0% for 12 months, something that is often used to encourage customers to sign up for a card. After the promotional period ends – usually 12 to 18 months -- your APR will jump to its standard rate, often 20% or higher.
  • Cash advance APRs: Avoid using your credit cards to withdraw cash from an ATM. These cash advances are expensive. Most credit card providers charge a higher APR for cash advances. If your card’s standard APR is 20%, your provider might charge interest of 24% or more for cash advances. That’s in addition to any fees – many credit card providers charge 3% or 5% of whatever amount of money you withdraw for each cash advance – on top of this higher interest rate.
  • Penalty APRs: Your credit card provider is allowed under federal law to charge a penalty APR if you pay your credit card bill 60 days or more late. This APR will be higher than your card’s regular APR, often running as high as 29.99%. And this penalty APR can stay in place for up to 6 months after you become current on your payments. Many providers will also charge a penalty fee, often as high as $40, if you make a late payment.

How To Calculate APR On A Mortgage

You won’t be required to calculate the APR on any mortgage for which you are applying. Lenders will provide this information to you, making it easier to shop around for the lowest-priced mortgage.

But if you want to delve into the math, here’s how to calculate APR on your own:

Because it is easier to give an example on a smaller loan, say you are taking out a personal loan for $2,000 and the loan's term -- the amount of time you have to repay it -- is 180 days. Say, too, that your lender is charging you $120 in interest and $50 in fees.

  1. Add The Fees And Total Interest

Your first step is to add your interest and fees. That's $120 plus $50, which comes out to $170.

  1. Divide That Sum By The Loan Principal

Next, divide that $170 by your loan’s principal balance of $2,000. The math will look like this: $170 / $2,000 = 0.085.

  1. Divide That Result By The Total Days In The Loan Term

The math gets a little tricky here, but now divide that 0.085 by the number of days in your loan’s term, 180. This time, the math looks like this: 0.085 / 180 = 0.00047222.

  1. Multiply That Result By 365

Now multiply the result from step 3 by 365. This equation works out like this: 0.00047222 ✕ 365 = 0.1723611.

  1. Multiply That Result By 100

Finally, multiply the figure from step 4 by 100 to get a percentage. In this case, you’d get 0.1723611 ✕ 100% = 17.24%. That final percentage is your APR.

And again, if that math seems complicated, don’t worry. Your lender will have already calculated your APR for you when you apply for a loan.

You can also rely on the calculator below to quickly work out a loan’s APR without doing the math yourself. Just plug in your loan’s interest rate, term, principal balance and other key figures.

Mortgage Fee Breakdown

Adjusts automatically as the fee amounts are changed.

Your Results

APR

Monthly Payment*

(Includes principal and interest)

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Why Is APR Important?

APR is the best way to find the lowest-cost mortgage.

Say a lender offers you a mortgage loan with 7% interest but an APR of 9.5%. Say another lender offers you a mortgage with a higher interest rate of 7.15%. You might think the first mortgage is less expensive. But if the second loan comes with an APR of 9%, it will cost you less than the loan with the higher interest rate.

The reason the second loan has a lower APR even though its interest rate is higher? Closing costs and fees. The first lender is charging a higher amount of fees, which makes its loan more expensive even with a lower interest rate.

The chart below gives another example: The loan with an interest rate of 6% can still be cheaper than one with a lower rate of 5% but a higher APR.

Loan Amount

$100,000

$100,000

Terms

5 years

5 years

Interest Rate

5%

6%

APR

10%

9%

Discount Points

2

2

Monthly Payment

$1,887.12

$1,933.28

Origination Fee

5%

5%

Estimated Fees

$12,600

$7,375

Annual Percentage Rate FAQs

Understanding APR and interest rates isn’t easy. Here are answers to some of the most common questions borrowers have regarding Annual Percentage Rates:

What is considered a good APR for a mortgage?

What makes for a “good” APR varies according to several factors, including the strength of your credit score, the type of mortgage you take out and whether mortgage interest rates are high or low when you are applying for financing. For instance, your APR will generally be lower if you take out a shorter-term mortgage, such as a 15-year loan, instead of a longer-term loan, such as a 30-year fixed-rate loan.

Can I lower the APR on my credit card?

You might be able to lower the APR on your credit card by contacting your card provider and asking for a lower rate. Your provider is under no obligation to drop your APR. You can increase your odds, though, by paying your credit card bill on time each month and building a strong credit score.

Does my credit score affect my APR?

Your credit score can cause your APR to rise or fall. Usually, your mortgage loan will come with a lower APR if your credit score is higher and a higher APR if it is lower.

Is APR the same as interest rate?

Your loan’s APR and interest rate are not the same. A loan’s APR includes both its interest rate and the closing costs charged by your lender and third-party providers. Because of this, your APR will always be higher than your loan’s interest rate. APR is a more accurate picture of the cost of your mortgage.

The Bottom Line: Look For Home Loans With A Low APR

If you are searching for a mortgage loan, pay attention to the APR quoted by lenders. It’s the best way to find the lowest-cost home loan. Ready to start your hunt for a mortgage? You can  start the mortgage process with us.

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Dan Rafter

Dan Rafter has been writing about personal finance for more than 15 years. He's written for publications ranging from the Chicago Tribune and Washington Post to Wise Bread, RocketMortgage.com and RocketHQ.com.