Chapter 09: What Is APR & Other Fees?

At this point in our home buying series, you should have a solid idea of what the home buying process looks like. In Chapter 8, we discussed the dos and don’ts of home buying and how to avoid making common buyer mistakes. In this chapter, we’ll go over what APR is and explore the other fees commonly associated with home buying. So, what is APR?

From credit cards to mortgages, APRs can be one of the most confusing aspects of securing a loan. While monthly or annual interest is rather straightforward, APRs encompass extraneous fees that aren’t immediately obvious. A higher APR can significantly affect how much money you owe, so isn’t it time to wrap your head around this slippery concept? Let’s take a closer look.

Understanding the definition of APR is important when securing a loan to buy a home. Keep reading to learn more about APR including answers to your most pressing questions like, “What is APR in a mortgage?” and “How do you calculate APR?”. We’ll also cover how APR affects all aspects of financing purchases including credit cards as well as examples of how to potentially lower APR.

Have a specific question in mind? Use the links below to jump straight to what you want to know:

• APR Definition
• How to Calculate APR
• What Is a Variable APR?
• APR for Credit Cards
• Types of Credit Card APRs
• How to Lower Your Credit Card APR
• How to Lower Your APR on Loans
• In Conclusion

What Is APR?

APR stands for “Annual Percentage Rate” and represents the rate of interest you’ll pay when you take out a loan. This could include closing costs, mortgage insurance, and any other expense associated with borrowing money. Essentially, it helps you understand how expensive it will be to take out a certain loan. The APR indicates some of the fees associated with the loan as an interest rate so you know what to expect in the long term life of the loan.

Interest vs. APR

Let’s break it down even further. When taking out a mortgage, car loan, or any other non-credit card loan, the interest rate and APR are defined as two separate amounts. 

• The interest rate refers to the percentage you’ll pay on a monthly or annual basis to borrow the money loaned to you. 
• APR refers to the full cost per year of borrowing the money, averaged over the full term of the loan. Typically, the additional fees included in an APR are added to the principal loan balance and accrue interest over the term of the loan.

It’s common for borrowers to get enticed by low monthly interest rates when they go loan shopping. Who wouldn’t choose a 5% interest rate over a 10% interest rate? But if the loan with 5% interest has a high APR, that signals there are additional expenses associated with the loan that could actually make it a more expensive choice. With a higher APR, your annual interest payments can increase since all of these extra fees you have to pay are tacked onto your original loan amount.

However, the terms of APRs vary depending on what type of money loan you’re taking out. Remember all those pre-approved credit card offers you get in the mail? You’ve probably seen the envelopes advertising 0% introductory APR as a way to entice you to sign up. The APR and interest rate are the same percentage for a line of credit because there typically aren’t any additional fees associated with opening a credit card. Even if you pay an annual fee or extra late fees, companies aren’t allowed to include those in the APR.

So to recap, when does APR really matter? Whenever you take out a loan that is not a revolving line of credit. Houses and cars are the most common examples of when you’ll be tasked with sifting through various APR offers. Remember, APRs give a fuller picture of what you’ll pay in interest and associated fees in addition to the principal amount of money you’re borrowing.

Why Is Understanding APR Important?

We’ve discussed in previous chapters in the series all the hidden fees that come with homeownership. Most people can’t afford to pay in full for a house and can only afford a small percentage in the form of a down payment, which means they have to take out a loan to pay off the rest. You pay off that loan in monthly installments with a mortgage. 

And just as there are hidden costs that come with homeownership, there are also hidden costs of getting a loan, like APR and other fees. This is also why it’s so important to talk to your mortgage lender and choose the right kind of mortgage in terms of:

• Credit score
• Employment history
• APR

Some of the most popular choices for mortgage loans are FHA loans and conventional loans. Before you can buy a home, you need to know the differences between FHA vs. conventional loans, as well as your other loan options, so that you can pick the better choice for you. 

Understanding the differences between different types of loans might seem confusing, but it’s crucial to understand the differences between loans, so that you can end up with a loan that you’re comfortable with. Don’t be afraid to ask your mortgage lender questions, as asking the right questions and choosing the right loan can end up saving you thousands of dollars in the end.

How to Calculate APR

Under the Truth in Lending Act, lenders are required to display APRs so borrowers can easily compare rates while searching for a loan or credit card. Even though APRs should be clearly stated on all documents related to the loan, it’s still helpful to know exactly how they’re calculated.

Here’s a quick example of how to calculate APR:

1. You take out a $400,000 mortgage with a 6% interest rate. This means you would pay $2,000 per month in interest or $24,000 per year. 
2. The additional fees on your purchase—such as closing costs, origination fees, and insurance—amount to $10,000. 
3. To determine APR, add these numbers. $400,000 + $10,000 = $410,000. 
4. Apply the 6% interest rate to this new number to determine the new annual payment. $410,000 x 0.06 = $24,600. 
5. The new annual payment is then divided by the original mortgage to get APR. In this case, $24,600 / $400,000 = 6.15% APR. 

What Is a Variable APR?

As you compare APRs, you’re guaranteed to see fixed APRs and variable APRs. The difference between the two options is rather simple: fixed APR is a percentage rate that does not fluctuate, while variable APR may change in relation to an index interest rate. The index your APR is based on can vary depending on the type of loan and the lender, but the Prime Rate drafted in the Wall Street Journal is one of the most common. This rate acts as a base number, and additional percentage points are added onto your APR from there depending on factors such as your creditworthiness, lender fees, etc.

The appeal of a variable APR comes with the idea that if the index decreases, so will your APR. Whether you choose a fixed APR or variable APR depends entirely upon personal circumstances and whether you are comfortable with the possibility of your loan payment fluctuating.

APR for Credit Cards

APR doesn’t just affect your mortgage, it’s also a major factor in credit card usage. 

As we mentioned earlier, a credit card’s interest rate and APR are interchangeable terms. If you don’t pay off your debt every month and carry over a balance, you will be charged a percentage of that balance in addition to the total amount you owe. That percentage is the interest rate (or APR) and does not include any additional fees. Typically, credit cards will have a range of different APRs based on your creditworthiness. It’s crucial to read the fine print of a contract before signing up for a credit card because you may find yourself paying far more than the introductory APR offering. Some credits may have as low as 0% APR for the intro period.

Another common phrase you’ll see when applying for a new credit card is “Prime Rate.” Cards with a variable APR—one that can fluctuate throughout the life of the line of credit—often use the Prime Rate as a benchmark from which to set their APRs.

Types of Credit Card APRs

Depending on how you use your credit card, you might run into various types of APRs with different percentages. Make sure to take a look at all the different rates to ensure you won’t get hit with a payment that will take a significant financial toll.

Purchase APR

This rate is the standard APR that applies to all the purchases you make on your card if you don’t pay off your debt by the monthly due date.

Penalty APR

This rate could apply if your payment is more than 60 days past due or a payment has been returned. Be aware that these are typically higher than your purchase APR.

Cash Advance APR

This rate can come into play when you use your credit card to withdraw cash from an ATM or cash a credit card check. These usually are higher than purchase APRs and apply immediately to the transaction without a grace period.

Balance Transfer APR

Depending on your credit card, you may be able to get a balance transfer APR for a low rate or even a rate of 0%. However, many cards still carry a significant balance transfer APR. This applies to any balance you transfer from another card onto your current credit card.

How to Lower Your Credit Card APR

Despite credit card APRs being rather straightforward, it’s never a bad idea to try and negotiate the lowest percentages that you can. However, there are risks involved when you ask for a lower APR. Your bank or credit card company may take another look at your account, and if they don’t like what they see, your line of credit has the potential to get docked as it could require a hard credit pull. Before you get on the phone, make sure you’re prepared.

Know Your Credit

Before making any requests to change your APR, make sure you know where your credit score stands. Do you have any late payments? Any recent credit applications? How about high debt-to-credit ratios? You’re allowed to order a free copy of your credit report once a year from each of the three credit bureaus, or can get a bigger-picture look at your credit health using services like TurboTax. While a credit score of 700 or above is considered good, the higher, the better. The higher your credit score and the cleaner your history, the more likely you’ll be able to negotiate a lower APR.

Gather Lower Rate Offers

A key part of the negotiation process is presenting competitive offers you’ve received from other credit cards. Translation? Show your current company that you’re serious about taking your business elsewhere if they won’t negotiate with you. Take a look at all the balance-transfer offers that are mailed to you or browse the websites of major credit card companies to find their best deals. Try to gather three to four rates that are better than your current card. Once you’re on the phone with a representative, be sure to mention these rates and how you’d prefer an APR similar to those offers.

Ask the Right Person

Persistence is key when negotiating a lower credit card APR. Call the customer service line on the back of your card and start the conversation. If the representative says they aren’t currently negotiating annual percentage rates, ask to speak to a supervisor. Sometimes, it’s all about talking to the right person. If you demonstrate to a manager your determination to get a better rate or take your business elsewhere, there’s more likely to be movement in favor of your request.

Remember, approach this conversation with a positive tone. Discuss how you’ve enjoyed your experience with this company and how your track record has proven your responsibility with handling a line of credit. Then it’s time to dive into how you could be getting better rates elsewhere but don’t want to go through the hassle of transferring balances. Even an APR reduction by a point or two could make a big difference and help you pay back your debt more quickly.

Be Prepared With Paperwork

While you’re on the phone, be sure you’re prepared to provide any additional paperwork your card issuer might want. This could include proof of income or past tax returns—any paperwork to prove that you are in a financial position to continue paying back your debt and deserve a lower APR. Even if these documents aren’t required, it’s never a bad idea to be overprepared.

How to Lower Your APR on Loans

Negotiating a lower APR for your mortgage, car loan, or other personal loan will likely take the route of refinancing instead of simply asking for a reduction. Refinancing is the process of transferring your current loan over to another lender or updating your terms with the current lender in order to take advantage of better terms and rates. A reduction in monthly payments could make a significant difference in paying off the loan or tamping down debt in other areas of your life.

Refinancing a Mortgage

Many homeowners choose to refinance their mortgages to take advantage of lower interest rates and APRs. The process typically follows these steps:

• Determine your goals: Whether you want to switch from an adjustable-rate mortgage to a fixed-rate mortgage, tap into your home’s equity, or get a better interest rate, figure out what you’re looking for during this important financial process. Going into negotiations with a specific goal in mind can help keep conversations on track and the outcome in your favor. You can also use Mint’s financial calculator to get a better idea of what to expect during your loan so that you can decide if making a change is necessary.
• Perform a credit check: Make sure there are no errors on your credit report that may jeopardize your ability to obtain a favorable loan. If you do find errors on your report, you can dispute them with the credit reporting bureau that provided your report to have them removed.
• Know the value of your house: Determine your home’s current value, either through checking recent home sale prices in your neighborhood or by getting an official appraisal. If your home is valued at or above the amount you want to refinance your loan for, it’s much more likely to be approved.
• Choose a lender: Check with the Consumer Affairs database to ensure you are refinancing through a qualified U.S. mortgage lender. Once you get pre-approved for a mortgage, your lender will tell you the potential cost of your monthly payments. They will also tell you about interest rates, closing costs, APR, and other fees that factored into your payments.
• Shop around: Don’t choose your current lender for the refinance option alone; look at other rates you could acquire if you switch lenders.
• Steer clear of fees: Understand what kind of fees and closing costs refinancing will require, and factor that into which offer you decide to take.
• Lock-in your rate: Determine an interest rate that suits your needs and lock it in before closing to ensure you receive the refinancing terms you want.

Refinancing a Car

To get a lower APR on your car loan, the standard steps for refinancing include:

• Performing a credit check: Take a look at your credit score to see if you’ll be able to qualify for a loan. A history of late payments could look like a red flag to lenders.
• Revisiting paperwork: Read through all of the terms for your current car loan and make sure you have a firm understanding of what you’re currently paying. Don’t go into a negotiation blind, otherwise you won’t know what APR offer is better than your current APR.
• Researching competitors: Shop around for other loans with better rates that fit your financial needs. It’s smart to leverage competing offers in order to bring the terms of your auto loan down to where you want them.
• Applying: When you submit an application, the lender will pre-qualify you if you meet all the requirements for obtaining a loan.
• Selecting an option: Depending on how many applications you submitted, you’ll be able to choose the refinancing option that works best for you.
• Finalizing the refinance: Enjoy the benefits of new loan terms and APRs that help you manage your repayment schedule.

At the end of the day, understanding the APR on your loan or credit card can make a huge impact on your financial health. Negotiating a lower annual percentage rate is never an easy task, but there are tips and tricks that can make it more likely to fall in your favor. 

With a firm grasp on how APR affects the repayment schedule of your mortgage or line of credit, reaching financial stability can be easier than ever before.

In Conclusion

So now that we’ve answered the question of “What is annual percentage rate?”, you should have a better understanding of how APR and other fees can impact your mortgage loan as well as credit cards and other loans. The lower your APR rate is on a loan, the better for you. A low APR rate means the overall cost of the loan will be lower, which can make the whole home buying experience—and being a homeowner—a lot less stressful. 

But before you can go ahead and make an offer on a home, it’s important to have a solid understanding of the home buying process, which we’ve been covering in the series. In the next and final chapter in the series, we’ll cover the various closing costs associated with buying a home and how negotiating a home price can save you substantially.

Sources: Office of the Comptroller of the Currency | Consumer Financial Protection Bureau | Wall Street Journal | FedPrimeRate.com | ConsumerAffairs