Jul 17, 2024
Michael Vandi
Understanding the total cost of borrowing for a mortgage can be confusing. One key metric that helps demystify this process is the Annual Percentage Rate (APR). When evaluating mortgage options, many borrowers wonder, "Does APR include closing costs?" The short answer is yes, APR does include many closing costs, but it's essential to understand which costs are factored in and which are not. This knowledge can empower you to make more informed decisions when comparing loan offers.
What Is APR?
The Annual Percentage Rate (APR) represents the yearly cost of borrowing money, expressed as a percentage. Unlike the interest rate, which only reflects the cost of borrowing the principal amount, APR includes additional fees and costs associated with the loan. These can include points, mortgage broker fees, and other closing costs. By incorporating these extra costs, APR provides a more comprehensive view of what you’ll pay over the life of the loan, making it easier to compare different mortgage offers.
Which Closing Costs Are Included in APR?
APR includes several fees that are part of the mortgage closing process. These fees can vary by lender, so it’s important to understand what is typically included:
Origination Fee: Also known as processing, administrative, or underwriting fees, these are charged by the lender for processing your loan application.
Private Mortgage Insurance (PMI): Required if your down payment is less than 20%, PMI protects the lender in case you default on the loan.
Discount Points: These are optional fees you can pay to reduce your loan's interest rate. Each point typically costs 1% of the loan amount.
Prepaid Interest: Interest paid upfront before the first mortgage payment is due.
Credit Report Fee: This nominal fee is charged when you apply for the mortgage.
Document-Preparation Fee: Charges for preparing the necessary legal documents for your mortgage.
Settlement or Escrow Fee: Fees for services related to closing the loan, such as escrow services.
Which Closing Costs Are Not Included in APR?
While APR covers many significant costs, not all closing expenses are included. Here are some common fees that are typically excluded from the APR calculation:
Title Fees: Costs associated with the title search and title insurance to ensure there are no legal claims against the property.
Notary Fees: Charges for notarizing documents during the closing process.
Appraisal Costs: The lender requires an appraisal to determine the property’s value.
Transfer Taxes: Taxes levied by local governments on the transfer of property.
Attorney Fees: Legal fees for services related to closing the mortgage.
Home Inspection Costs: Fees for inspecting the property before purchase.
Credit Report Fee: Although sometimes included, this fee may also be separate.
Recording Fees: Costs for filing the deed and mortgage with the local property records office.
Why the Difference Matters
Understanding the difference between APR and interest rate is crucial when comparing mortgage offers. While the interest rate gives you an idea of your monthly payment, the APR provides a fuller picture of what you’ll pay over the life of the loan. This can include fees that might not be immediately apparent when only looking at the interest rate.
For example, suppose you’re considering two mortgage offers:
Lender A offers a loan with a 5.5% interest rate and $6,480 in closing costs, resulting in an APR of 5.575%.
Lender B offers a slightly lower interest rate of 5.475% but has higher closing costs of $10,800, leading to an APR of 5.6%.
Despite the lower interest rate, Lender B’s loan is more expensive in the long run due to the higher APR. This demonstrates why APR is a more reliable measure for comparing the true cost of different loan offers.
How to Compare Loans Using APR
Comparing APRs can be a straightforward way to determine which mortgage is most cost-effective, but it’s essential to consider all loan terms. Here are some steps to help you compare loans effectively:
Get Multiple Loan Estimates: Request loan estimates from at least three different lenders. Each estimate will include the loan’s APR, interest rate, and an itemized list of closing costs.
Review All Loan Terms: Look beyond the APR and interest rate. Examine the loan term, monthly payment, and any potential penalties, such as prepayment penalties or balloon payments.
Consider Fixed vs. Adjustable Rates: Fixed-rate loans provide stability with constant interest rates, while adjustable-rate mortgages (ARMs) can fluctuate. Be cautious when comparing APRs for ARMs as they may not reflect the maximum potential interest rate.
Check for Rate Locks: Ensure that the interest rate and APR are locked in. If not, they could change before closing, affecting your overall costs.
Evaluate Additional Costs: Consider all additional fees that may not be included in the APR. This comprehensive view will give you a better idea of the total cost of each loan.
The Importance of Transparency
Transparency is critical when dealing with mortgages. Lenders are legally required to disclose the APR when you apply for most types of home loans. This disclosure helps you understand the full cost of borrowing and allows for easier comparison between different loan offers.
To ensure you’re getting the best deal, ask your lender to clarify which fees are included in the APR and which are not. This will help you avoid any surprises at closing and ensure that you’re fully aware of all the costs associated with your loan.
Conclusion
The APR is a vital tool in understanding the true cost of a mortgage. By including many of the closing costs, APR provides a more accurate measure of the loan’s overall expense compared to the interest rate alone. When shopping for a mortgage, always compare the APRs of different loan offers, but also be mindful of any fees not included in the APR.
By taking the time to understand APR and its components, you can make more informed decisions, avoid unexpected costs, and secure the most cost-effective mortgage for your needs. Whether you’re a first-time homebuyer or refinancing your existing loan, a clear grasp of APR will guide you toward better financial choices.
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