What is Annual Percentage Rate (APR)
It’s very important to know your APR because it’s a vital part of knowing your loan amount. Most borrowers tend to prefer loans that have low APRs.
The overall fact of the matter is that an individual should know that it comes at a cost. For instance, the lender may require you to pay other fees and discount points. This article will reveal to you that having a low APR doesn’t mean that your loan is cheaper.
Moreover, people use the APR to determine what banks they want to associate themselves with mortgages being the most prominent. There is more knowledge to know about regarding this subject. In this article, you will learn what an APR is, how to calculate it, why it’s so important, etc.
Differences Between Interest Rate and APR
In order to understand these two terms, the first thing you need to know is what a principal is. In a nutshell, the principal is the amount of money a person borrows from the lender.
Let’s say that you take a loan of an amount of $10,000. The principal is $10,000. The money you pay on the principal is the interest rate. For example, if your interest is 8.5% the amount you owe on what the lender let you borrow is $850.
The APR is more difficult to predict. Moreover, it’s the overall cost of your loan. This means that the amount of interest you pay is only part of the APR. The cost of attorneys and application fees is also a part of the APR.
Overall, the APR is the presents forth the cost of a loan as a whole and not just the interest rate an individual pays back to the bank. This is one of the main reasons why borrowers use the APR to determine which bank they affiliate themselves with.
The APR always consist of the interest rate. Moreover, the more identical the two rates are, the better the deal a person gets.
There are loans that make it very clear regarding how much interest you have to pay. In other cases, the interest rate changes.
We call this a variable APR; this is when the interest rate fluctuates as time progresses. Most people assume that their APR becomes lower as time passes, but it’s really the opposite.
Pros and Cons of Variable-Rate Loans
The first thing to know is that variable rates trick people very easily. At first glance, it appears that you can afford the loan. As the interest rate increases, the amount you pay per month is increases. This catches people off guard often.
The good thing about having a variable rate is that the intro rate is significantly lower than the typical rate. This is one of the main ways banks reel people in.
What causes an increase in the interest rate?
Remember, a variable APR increases with time. One of the main reasons why this happens is because of interest increase in the country overall. The APR does the same exact thing if interest rates on other accounts increase too.
If there is a spike in an individual’s APR, it could mean that they have missed payments or was late paying in general. As a result, this can lead a person to have a bad relationship with their bank.
Why should homeowners plan to sell their home not rely on APR?
Remember, people who have a mortgage and desire to sell their property (within 7 years) should not worry nor even consider APR.
APRs include the interest as well as other fees. Banks typically charge these fees that range between 0.5 -1 percent of the whole sum.
Helen has two offers from two completely different banks. The first bank offers her a 25-year mortgage. The total amount is $100,000 with a 6% interest rate and 6.3% APR. The second bank offers her rates of 5.75% and 6%. On the surface, it seems as though the second bank has the better option for Helen.
However, we almost forgot about the fees, did we?
Let’s say that the first bank wants $5,000 in fees and the second banks require $10,000. If you calculate what this looks like for 7 years, one can see that the first bank charges a lower APR than the second one. On the contrary, the second offer would be more appealing if the fees were the same.
What Is An Adjustable-Rate Mortgage (ARMs)?
The market index(s) determines the rates of a mortgage.
ARMs are connected with Cost of Funds, LIBOR, other indexes and prime rates. Since ARMs are based on technicalities, it will affect how your payments are different from one another.
Moreover, always ask the lender why they prefer one over the other.
ARMs Take A Number of Different Forms
If there is a periodic cap set for 2% per year and the rates increase to 4%, your rates will not increase but stay at 2% because of the cap.
Lifetime caps are very similar. If your lifetime cap is 7%, it is guaranteed that your rate won’t go above the 7% cap deal you made with the lender.
The differences n interest rates (in excess amounts) can accumulate every year. As a result, it impacts your mortgage payment.
The Different ARMs
There are plenty of ARMs to choose from as you observe. You might even see these types when you’re shopping:
- 8/1 ARM – The fixed rate is eight years; then it adjusts each year.
- 9/2 ARM – The fixed rate is nine years; then it adjusts every two years.
- 3 Year – The fixed rate is 3 years; then it adjusts yearly.
Indexes / Margins
When the fixed rate period is no more, ARMs move over to another interest rate. This is termed the index. The index is established by a neutral group. It relies exclusively on market forces. A typical loan document presents what index an ARM. On the other hand, there’s aplenty they follow.
Most mortgages rely on one of three indexes:
The London Interbank Offered Rate, the 11th District cost of funds index, or the maturity yield on one-year Treasury bills.
The first thing to do is understand the rate:
The lender sets ARM rates (learn how to find the best mortgage lender) by taking the index rate and adding percentage points (margin). There are many considerations that determine what rate you qualify for. Your credit score is the main consideration. If you don’t know your credit score, there are many ways to find out what it is.
Remember: Margins cannot change – the index rate can.
Example: the index is 1.75%. The margin is at 2 percentage points. The total adds out to 3.75%. Moving forward, if the index changes to 2%, your interest rate increases to 4%.
Like I said before, margins don’t change; only the index.
Another Example: You have an index of 7% with a 3% margin. This adds together to a 10% interest rate. Let’s say the index shifts down to 4%; then your new interest rate is 7%.