Lessons in Loan Lingo: What is APR?
When the first time homebuyer begins pouring over the mathematical formulas that make up a mortgage, she may feel like her head it exploding. At least, I did. The number of acronyms scattered aout a typical loan document is cofounding—often so much so that fledgling loan applicants miss very important points. That’s what this series is about: teaching first-time buyers the lingo of lending. Today I attempt to illuminate the difference between APR and APY.
Both APR (annual percentage rate) and APY (annual percentage yield) refer to interest you pay on your mortgage. But beyond this commonality, they are quite dissimilar figures. I’m only going to cover APR today, in the interest (pun intended) of not exploding any heads. I’ll return in a week or so to cover APY, giving you time to digest in between lessons.
APR is the annual rate of interest you pay on your loan amount. But it’s not just interest on the original loan if you bought down interest points or are paying for private mortgage insurance as well. APR includes the interest rate you locked with your lender plus all additional fees you’ve wrapped into your loan. The APR then is a more complete measure of a loan's cost.
The confusing issue for we new buyers though is that the loan's interest rate, not its APR, is used to calculate the monthly principal and interest payment when you look at a loan document. Example:
Here is the supposed monthly payment on a $200K loan at 3.25%. The calculator I’m using comes from Bank Rate.com.
But in truth, you are likely to pay much more if
- a) You need PMI because you could not or chose not to put 20% down.
- b) You paid an origination fee on your loan (I can’t imagine whom this won’t apply to).
- c) You paid down interest points.
- d) You wrapped home insurance and property taxes into your loan.
Now, clearly the point of this particular calculator is to figure savings by buying down interest points. But it’s very useful to show you APR as well, because I had to enter the cost of buying down points. I also entered figures that include a PMI, origination fee, etc., etc. The result looks a lot more like what your actual monthly payment will be.
Having paid a few house payments on my new home, I know this total is much more accurate. So the lesson? Know the APR, not just the interest rate. That’s the only way you can really know your monthly payment, and therefore know if you can really afford this home in the first place.
Anna Marie Erwert writes from both the renter and new buyer perspective, having (finally) achieved both statuses. She focuses on national real estate trends, specializing in the San Francisco Bay Area and Pacific Northwest. Follow Anna on Twitter: @AnnaMarieErwert.