Why Annual Percentage Rate Sucks

Annual Percentage Rate Sucks…Period. I’ve written about this before but it’s worth revisiting as this is the most helpful advice I can offer you when it comes to your home mortgage. Here’s why APR sucks and why you should avoid it like the plague.

Annual Percentage Rate is one of the most commonly used yet controversial mortgage terms you’ll encounter when shopping for the lowest refinance rates. Trusting your lender’s APR when shopping for mortgage rates is like trusting a bad neighbor. Next thing you know the fridge is empty and there’s money missing off the dresser.

Annual Percentage Rate Definition

Annual Percentage Rate is a term lenders love to sling around when advertising refinance rates. What does Annual Percentage Rate or APR really mean? Annual Percentage Rate was intended to represent the real cost of a home loan over time, expressed as a yearly interest rate. This sounds good on paper because the APR is supposed to take into consideration closing costs and other fees associated with the home loan.

It doesn’t matter if you’re purchasing a home, refinancing your existing loan or considering a home equity loan, you’ll find the interest rate and Annual Percentage Rate are not the best way to choose from today’s best mortgage lenders. The idea behind Annual Percentage Rate is that it should tell you the interest rate your home loan would have if you paid no fees out-of-pocket whatsoever.

The problem with Annual Percentage Rate is that it makes several assumptions about you that are almost never true AND lenders use some creative accounting when it comes to discount points. Lenders are required by Truth-in-Lending laws to provide you an APR when you get quotes for a home loan. You’ll find it on the Federal Truth-in-Lending Disclosure Statement you receive with your Good Faith Estimate.

What’s Wrong With APR?

Annual Percentage Rate was intended to allow you to make apples-to-apples comparison of different mortgage offers from different lenders. If you rely on APR to choose from today’s best mortgage companies an offer with an interest rate of 4.0% and an Annual Percentage Rate of 4.25% would appear to be better than a similar home loan with an interest rate of 4.0% and an APR of 4.5 percent.

Here’s my advice for you today when it comes to APR and getting the best refinance rates for your next home loan:

Never shop for a home loan based on the APR. Ever.

It doesn’t matter if you’re refinancing with a conventional loan, VA, FHA or jumbo mortgage loan, basing your decision on the APR decreases your chances of getting the best deal. Mortgage lenders manipulate APR to make their offers seem more attractive and get away with this because there are no standards for calculating Annual Percentage Rate.

This is why Annual Percentage rate is never the apples-to-apples comparison that it was intended to be. The mortgage offer with the lowest APR often has the highest closing costs meaning more cash out of your pocket.

Banks and lenders love to beat the “Low, Low APR” drum when marketing their offers. The refinance rate quotes you collect are likely to be sorted by APR with the lowest Annual Percentage Rate appearing first.

They do this because the refinance quotes highlighted with the lowest APR include the highest discount points. Paying discount points with today’s ridiculously low mortgage refinance rates is a total waste of money. If you agree to pay unnecessary discount points on your next home loan you’ll have lower payments over the lifetime of your mortgage and the loan offer will even appear cheaper because it will have a lower APR than a zero point offer.

The bottom line when it comes to APR is the mortgage with the lowest Annual Percentage Rate is going to have the highest closing costs thanks to unnecessary discount points. If you’re paying discount points at closing in today’s market you’re wasting your money. Period.

APR assumes you’ll keep your home loan for the entire duration of the 30-year term. Considering the average homeowner refinances their mortgage every four to five years the chances of recouping your mortgage fees becomes slimmer and slimmer the more you pay at closing.

How Should I Shop For Mortgage Rates?

The best way to shop for the lowest purchase or refinance rates is to compare mortgage rates AND fees, focusing on the loan origination fee. Avoiding discount points completely and trying to find the lowest origination fee will make sure your out-of-pocket expenses are minimal AND you’re getting today’s great rates.

I’ve seen loan origination fees as low as a flat $400 from community-based credit unions. These credit unions are an excellent starting point for your mortgage rate shopping.