Several factors can affect the overall price of your home. Factors may include closing costs, legal fees, and the interest rate you get on your mortgage. Also, there are different types of interest rates that can affect your mortgage's cost, including annual percentage rates (APR) and annual percentage yields (APY). If you’re wondering what the difference is between APR vs. APY mortgage rates and how they affect your total cost of homeownership, be sure to keep reading.
Understanding Your Interest Rates
An interest rate is a cost that a lender charges a borrower when they borrow money. The amount of interest a person is charged depends on their credit score, the loan amount and more. The lower the interest rate on a mortgage, the lower the amount the borrower will owe on the home over time.
APR, or annual percentage rate, is a more accurate indicator of how much a loan will cost because it includes the fees that lenders charge for originating a loan. However, it is only accurate for loans based on simple interest. For loans with compounding interest, APY is a more accurate indicator of a loan's total cost.
APY, or annual percentage yield, is a more accurate measure of the yearly cost of a loan than APR. It is most applicable in situations where interest compounds, such as credit card debt. However, if you are considering a mortgage, APY is usually higher than your APR.
What Is Annual Percentage Rate (APR)?
When shopping for a loan, home buyers do not have to do the math on their APR alone, nor do they have to look far for it. The Truth in Lending Act of 1968 states that lenders must provide people with a disclosure statement that includes the APR of a loan. It must also include any charges, a list of scheduled payments, and the total dollar cost it will take to repay a loan if the mortgage is held until the end of its term. Therefore, home buyers can ask their prospective mortgagors about the APR on their loan.
What Is Annual Percentage Yield (APY)?
APY is the measure of the yearly cost of a loan, including interest compounded. In most cases, APY will be higher than the APR. If a loan only compounds once per year, the APR and APY will be the same.
Borrowers can find APY by asking their lender.
Why Compound Interest Matters
Compounding interest is calculated on the initial principal of a loan and the accumulated interest of prior months. If interest compounds monthly, this means that the first month of a loan's origination accrues interest. The second month accrues interest both on a loan's principal and its interest in the first month. This trend continues throughout the life of a loan and is most common in credit cards.
Therefore, the inclusion of compound interest in APY can have significant implications for borrowing and investing.
APR And APY In Practice
When shopping for mortgages, you must interpret both APR and APY. As a borrower, you should always search for the lowest possible rate on your mortgage. Although quoted rates from a mortgagor may seem low, you could end up paying more than you initially expected if you do not understand the APR and APY on your loan.
A Mortgage Example
Let’s say that you take out a $100,000 mortgage at 3.99% interest compounded quarterly. Quarterly means that your loan will be charged a quarter of the interest for the year, or about .9975% interest. At the beginning of the year, your loan would have a balance of $100,000. After the first quarter, it will be charged .9975% interest, or $997.50.
In real life, you’d be making monthly payments over the quarter that decrease the balance of your loan. However, for this example, let’s assume you are not making payments. At the beginning of the second quarter, the balance of your loan would be $100,997.50. When the interest accrues again in the second quarter, the compounding interest charge would be $1,007.45. Therefore, the balance of the loan would have increased to $102,004.95.
Over a year, the balance of this loan would grow to $104,050.10. This means that it would have gained $4,050.10 in interest or 4.05% of the loan's total balance. The APY on this loan is 4.05%. The APR on this loan was 3.99%.
Therefore, compounding interest increased the total cost of a loan. It is essential to understand all the terms and rates on your loan before taking out a mortgage.
Interpreting What Rates Mean
When doing your homework before you take out a mortgage, it is essential to know that APR and APY might be used in different situations to alter the appearance of the amount of savings or debt that you are taking on. For this reason, you should always get both the APR and the APY on paper before you sign a mortgage document. When you understand all the figures that go into your mortgage, you will be better equipped to make your monthly mortgage payments and be financially successful.
APR And APY Tips For Home Buyers
When buying a home, there are several things you should be aware of regarding APR and APY. These include:
- Compare rates: It is always essential to shop around for rates. You might want to speak with national bank chains as well as local credit unions. This is an essential step in the home buying process. The right lender will not only have reasonable rates but will be able to answer any questions you have about the mortgage process. Feel free to speak to one of our Home Loan Experts.
- Find a lender you trust: One way to ensure you get the best rates on your mortgage is to shop around for a lender. Some lenders may advertise lower APR but have higher APY than others. Therefore, find a lender that not only has a great rate but that you enjoy working with. It will make the whole lending process more comfortable.
- Use a calculator: You can use a loan calculator to help you determine how much interest you’ll earn each year based on your APY, the principal of your loan, and how long you plan to save. Calculators can also help you see if making extra payments on your mortgage or larger down payment will save you more money in the long run.
If you’re ready to move forward and look into mortgage options, get started online!