Interest Rates Vs. APRs

Posted September 1, 2009 – 1:55 pm in: Loans
     

For those who are considering purchasing a new home, you will obviously need to speak will lenders about a mortgage. It is easy to make mistakes when it comes to borrowing or overlook the key terms you need to understand regarding your mortgage including, interest rates and APRs. Ultimately, your goal is to get a loan, however if you do not fully understand the meaning of these words, you might find yourself in a loan that you are not satisfied with, and the interest rates and APRs of your loan will definitely affect your ability to pay back your obligations. Because of this, before you speak with the lender, read below regarding the details of interest rates and APRs so you are educated about the facts of borrowing.

It is not uncommon to assume that interest and APRs are the same thing, because both of them relate to fees we incur for borrowing money. However, although they may seem similar, they are actually different and it is important not to confuse the two. Understanding the difference will help you understand whether or not you will be able to pay back the loan or not, and that will be imperative when you decide whether or not to actually borrow from the lender.

It is easier for most people to understand interest because interest is more straightforward and simple. For example, when it comes to your mortgage, usually your interest is determined by the principle and the term of the loan. However, many nave people assume this is the only factor affecting interest and the overlook other important factors that can affect interest rates.

There are specific factors that affect interest, one being the type of loan that you take out - is it a fixed loan, and ARM loan, etc? Also, the amount of interest you pay on your home mortgage takes into consideration the amount of your loan versus the value of your home. Lastly, interest is evaluated based off the type of property you are purchasing - is it for your primary residence, a second home, or an investment property?

One of the greatest things about a mortgage is the opportunity to buy down your interest rate by paying more up front. When you buy down you receive a point for 1 percent of your total principle that you pay up front. For example, you could buy down 5 points in interest if you paid $5,000 up front for a $100,000. Buying down interest rates are not only a great way to lower the interest rates, but they also save you money and can possibly allow for tax benefits.

If you do not know how to calculate interest, it is actually quite simple. You divide the total amount of interest charged from the loan by the total amount of the loan; therefore, if your lender loans you $10,000 and charges you $100 in interest your interest rate is (100/10000) x 100 percent = 10 percent. Computing interest rates always simple, even if the numbers are a little bit more complicated.

APR is short for Annual Percentage Rate, and it calculates the total cost of a mortgage including closing costs and interest over its entire term. The APR is reflected as a yearly rate. While it includes interest in its calculations, it is an effective way to compare mortgages because it tends to best reflect the true cost of the loan. If you overlook the APR, you might overlook some of the cost that you need to anticipate in the future.

Since APR considers all costs for the future other than the principle, not just the interest rate, it is usually a higher rate than the interest rate. The calculation for APR is a little more complex than the simple calculation for interest rates and it usually involves an amortization schedule and a more complicated equation. However, because of this APR is a good prediction of future costs.

When you do apply for a mortgage, do not be surprised when both the interest rate and APR are discussed. The rates will definitely vary given you credit score and the conditions of the market. Yet, those who better understand the terms will make more informed decisions when it comes to borrowing.

Also, although you may not have much control on the interest rates and APRs at the time, you do have more control on the controlling costs that come with your new mortgage. These costs are usually the initial cost like closing costs and mortgage insurance. Make sure to negotiate them with your lender because they have flexibility with them.

As always, now that you are more informed regarding the terms and practices of lending, it is always wise to shop around. Although the first lender may be willing to give you a loan, it may not be right for you. Do you research and find the best fit for you.

Mortgage refinancing can make your monthly mortgage more manageable.

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