Most people who are in the process of either getting pre approval for a home loan or those that have already been formally approved understand the concept of interest rates and the impact that this will have on their overall costs over time. However, a common question that we are asked is ‘what is the difference between the interest rate, and the APR or annual percentage rate’?
An interest rate is a simple calculation that determines the percentage of the total value of the loan that will be payable by you, in order to access the capital to purchase your property. Whilst this rate can fluctuate over time depending on the current RBA interest rates, and lending institutions, the method to calculate this rate is quite straight forward.
The APR, on the other hand, is a truer percentage that represents the total cost of the loan, including all fees, charges, LMI that is required to be paid over the course of the loan.
APR, is not quite as straightforward as there are a lot of different factors that need to be considered when it comes to calculating the true APR of your home loan product.
Interest rate vs. APR
Your home loan interest rate is a percentage that represents the amount of additional money you will repay on top of your principal each year for the outstanding balance of your loan. The rate can be variable or fixed and is generally calculated at a daily, weekly or monthly frequency. Regardless of how much you borrow, or how long you borrow it for, the rate is an easy way to determine how much additional money you are agreeing to pay in order to receive access to these funds.
The APR on the other hand, is a broader calculation, which can be brought back to a percentage which also includes all of the fees, charges, costs and expenses that come with that particular lending product.
Why you need to consider both numbers?
Both the interest rate, and the APR are ways for consumers to compare different lenders and products. APR however, provides a more comprehensive representation of the true cost of the loan and therefore should be prioritised over interest rate alone when it comes to making a final decision on which product is right for you.
Whilst this can be complex, our team of experienced lending consultants will be able to help you easily calculate and compare the different interest rates and APR for your home loan options.
Monthly repayments vs total cost.
Whilst the interest rate will help you determine the monthly repayment amount for your loan, taking time to explore the true cost of the loan through APR may bring some surprising results. Because APR factors in total cost of access, which includes things like monthly fees, annual fees, payment terms, late fees or early exit fees, it provides are more accurate representation of the true nature of the facility. In the USA, lenders are required to publish the APR of their products however in Australia this is not the case. Borrowers should always take the time to calculate this rate as a part of their due diligence in evaluating and comparing different home loan products.
Example:
| $200,000 mortgage with different rates, APRs | |||
| Interest rate | 4.5% | 4.25% | 4% |
| Total Fees and Charges | $2,800 | $5,800 | $8,800 |
| APR | 4.619% | 4.492% | 4.36% |
| Monthly payment | $1,013 | $984 | $955 |
| All costs, 3 years | $39,281 | $41,220 | $43,174 |
| All costs, 10 years | $124,404 | $123,866 | $123,380 |
| All costs, 30 years | $367,613 | $354,197 | $343,739 |
As you can see in the example above, whilst the 4.5% interest rate at face value would appear to be the more expensive option, when we factor in the other costs of the loan facility and calculate the APR of the loans, that product is actually better than the comparison products when considering the total cost at the three year mark.
As a smart home buyer, you should enlist the help of an experienced mortgage broker to ensure that the deal you think you are getting is what you are actually getting.
Time Matters
If you are planning on a taking out your home loan for a long period of time, as most home buyers are, then the APR is especially important for you to consider. Monthly and annual fees add up very quickly on a 30-year loan.
That being said, if you are planning a more short term investment, the APR needs to be calculated and adjusted to the reduced life of the loan as most APR calculations take into account the full span of the loan assuming that you are going to pay the loan off entirely, rather than sell the property and exit the loan early.
If you need assistance with calculation the APR of your current loan or are wanting help building a true comparison of options you are considering, then reach out to one of our experts today.
