According to NAR, 4.09 million homes were sold in 2023. Of these many homes, 32% were bought by first-time buyers. For first-time home buyers, it’s essential to understand all costs involved in the home-buying process.
The interest rate is the cost you pay for borrowing money. APR (Annual Percentage Rate) is the total cost associated with borrowing. APR costs include interest rates, origination fees, insurance, etc.
Before you commence your home-buying journey, calculate all the associated costs now.
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What Is Interest Rate?
An interest rate is a cost you pay for borrowing money, expressed as a percentage. It is the cost that a borrower pays the lender on top of the principal amount.
The lender considers the borrower’s credit score and debt-to-income ratio to set the interest rate. Other factors that impact the interest rate are the loan amount and loan span.
Interest rates significantly affect a homebuyer’s ability to buy. Higher interest means higher monthly mortgage payments, making home affordability difficult.
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What Is APR?
APR refers to the total annual cost of borrowing. In other types of loans, APR usually includes the interest rates and origination fee. As for mortgages, APR contains the following costs:
- Interest Rates
- Loan Origination fees
- Underwriting fees
- Mortgage Points
- Mortgage Insurance Premiums
- Other Closing Costs
Under the Truth in Lending Act, lenders are to send an APR estimate to the borrower within 3 days of receiving a mortgage application.
How Is Interest Calculated?
Interest rates are determined based on the loan duration. Short-term loans are calculated using the simple-interest method. For larger duration loans the amortization schedule method is used.
The formula for calculating interest:
Principal Loan Amount x Interest Rate x Loan Term = Interest
Example: If a take out a 5-year loan for $60,000 with an interest rate of 5%, the interest would be: $60,000 x .05 x 5 = $15,000.
For precise calculations of interest based on your loan term, use a mortgage calculator. It gives you an accurate breakdown of interest costs over the loan duration, making it easier to understand your financial obligations.
How Is APR Calculated?
To calculate the APR on your mortgage, you will need the following details of the loan:
- Principal Loan Amount
- Interest Rate
- All Other Costs
The formula for calculating the APR:
APR= (Interest Costs+Other Costs) / Principal / n x 365 x 100
Bottom Line: APR vs Interest Rate
The interest rate is the amount the lender charges a borrower as a lending cost. APR is the cost that includes interest and all other fees that you pay to the lender.
As a home buyer, it’s important to ask your lender for the details of APR and interest rate. Make sure you compare both metrics from different lenders before you close on a mortgage.
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Frequently Asked Questions
What does APR stand for?
APR stands for Annual Percentage Rate.
Why is my APR higher than the interest rate?
APR is higher than the interest rate because it includes the interest on the loan, origination fee, mortgage points, etc.
Does 0% APR mean no interest?
Yes, 0% APR means that there is no interest charged on that particular transaction. Usually 0% APR is offered for a limited period as a part of lender's promotional scheme.
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