Myth # 2: APR is how you should compare loans.
Contrary to the popular mortgage wisdom, APR is not the ideal way you should compare loans.
APR is a common mortgage term that is often casually thrown around within the lending industry. As a consumer, it is important to understand exactly what your APR is, and how it affects you as a lender.
APR stands for Annual Percentage Rate. Your APR is basically the overall total of how much it costs for you to borrow money. This total includes the interest rate, the points, mortgage broker fees, and any other charges that you may have to pay when getting a loan. Because your APR includes all of these additional costs, that is why it is typically a higher number than your interest rate. The APR was initially introduced with the goal of helping borrowers compare different loan products, but unfortunately, this tends to lead to more confusion – especially when the product is an adjustable rate mortgage (ARM).
One alternative to this is to compare loan amount to loan amount. A total loan amount would consist of the payoff, closing costs, and escrow. For example, if your payoff is 100,000 dollars, and your closing costs and escrow amount total 10,000, then the total loan amount is 110,000 dollars. Therefore, if one lender offers you 108,000 fixed at 4 % interest, 30 years fixed, and another lender offers you 110,000 at 4 %, 30 years fixed, which one do you think is the better value?
The key to determining the best value is to make sure that all relevant costs are included. When comparing loans, lender fees are generally the only item that varies. The other costs included in the total amount of the loan typically remain the same. Another method of comparing loans is to compare loan payments. In keeping with the above example, the comparison of loan payments would look like the following:
$110,000 loan – 30 year fixed – 4 %
Monthly payment: $785
$108,000 loan – 30 year fixed – 4 %
Monthly payment: $772
In comparing the payments, the second loan is obviously the better. This easy system will help you to compare mortgages quickly and accurately without the added hassle of trying to understand your APR. When in doubt about the mortgage you should select, do a quick comparison of the overall total costs of the loans and of their monthly payments. This will point you in the right direction and help you to get the better deal.