When you’re ready to buy a house, keeping your costs down is no doubt a priority. For this matter, you may diligently meet with multiple lenders and request mortgage quotes. Comparison shopping is by far the best way to acquire the best rate on a home loan, as this has a bearing on affordability and purchasing power. But once a lender responds to your request, you may be puzzled because your annual percentage rate (APR) is higher than your interest rate.
Some homebuyers mistakenly believe that the terms “APR” and “interest rate” are interchangeable. Although both refer to costs associated with acquiring a mortgage loan, there are key differences. Knowing these differences not only increases your personal knowledge, it also helps you decide whether a loan makes financial sense.
The interest rate is simply the yearly fee you pay to borrow money from a bank. But as any homebuyer knows, the cost of buying a house doesn’t stop with interest. This is only one factor, and APR includes your interest rate plus any other costs associated with the property. Therefore, it is common for your annual percentage rate to be more than your interest rate. What expenses contribute to a higher APR?
1. Private Mortgage Insurance
The inability to save enough money prevents many people from buying a home. But there’s good news for homebuyers. Most mortgage lenders do not require the traditional 20% down payment, and they allow homebuyers to purchase with as little as 3.5% down, depending on the type of loan. This is excellent news if you have a small bankroll. But if you don’t put down at least 20%, your lender will require private mortgage insurance (PMI).
This type of policy protects your lender, not you. This guarantees that your lender gets paid if you default. Private mortgage insurance costs between 0.05% and 1% of the loan balance annually. This isn’t a separate payment, but rather premiums are included in your mortgage payment, thus increasing how much you owe each month.
Mortgage lenders typically drop private mortgage insurance once you acquire at least 20% equity.
2. Loan Origination Fee
This fee varies, but it’s typically 1% of your loan balance. This is the lender’s fee for processing your loan paperwork – so, it basically covers the bank’s costs. Origination fees are paid at closing.
3. Other Closing Costs
If only closing costs stopped with the loan origination. Unfortunately, other one-time costs also factor into a higher APR.
Buying a house is an expensive transaction. Not only because you’re acquiring a home costing hundreds of thousands of dollars, but also because of other expenses. Total closing costs can range between 3% and 5% of the purchase price and include a variety of fees, such as discount points, prepaid interest, attorney fees, escrow fees, recording fees and title search fees.
Closing costs aren’t avoidable, and even if a lender offers a low or no-cost mortgage loan, they typically compensate for this in other areas, such as by charging a higher interest rate on the home loan. Understand, however, that closing costs are negotiable. And if you’re able to reduce your discount points or negotiate a cheaper origination fee, this can lower your annual percentage rate.