Why Advertised Mortgage APRs Can Be Misleading And What You Can Do About It

It’s no secret that shopping for a mortgage can be overwhelming and frustrating. One issue homebuyers face? It’s nearly impossible to get a transparent idea of a lender’s APR until you’ve applied for a mortgage.

And the truth is, an APR doesn’t tell the whole story about what you’ll really pay for your home. There are a whole host of fees that aren’t included in APR calculations.

The result? Homebuyers can be hit with higher fees than expected, adding thousands of dollars to their home loans.

Want to shop for a mortgage with confidence? Here’s what to look out for and how to protect yourself:

What’s an APR?

First things first. What’s an APR? It’s the total cost of financing your home, expressed as a percentage you’ll pay each year.

APR goes beyond the mortgage rate you’ll pay. It’s your base mortgage interest rate plus any finance charges that will be paid along with your loan.

APR is meant to be more of an all-inclusive price. It’s higher than your mortgage interest rate because it includes lender costs like loan origination fees, broker fees and discount points.

How your APR is determined:

The main portion of your APR is determined by your base mortgage rate.

The mortgage rates you’re offered can vary dramatically from lender to lender and depend on factors such as your credit history, personal finances, the location and cost of your home, and when and if you choose to lock in that rate.

And as if that isn’t complicated enough, your APR is further affected by a variety of finance charges, many of which are controlled by the lender.

These baked-in finance charges depend on: any and all lender fees the mortgage company charges, closing costs and fees, the type of loan, and the rate you select (which may require payment of discount points).

Pro tip: Lender fees are optional (as in, mortgage companies don’t have to charge them — they choose to) and can add up to as much as 1% to 3% of the total loan amount. You can save substantially by working with a mortgage company that charges zero lender fees.

APR is never apples to apples

To further confuse matters (as if that were possible!), every lender chooses what fees they’ll charge, which means the fees that are included in APR can vary greatly from lender to lender.

So it’s truly impossible to make an apples to apples comparison without getting a loan estimate listing out each fee.

The only problem? You have to apply for a mortgage before a lender is required to provide you with an itemized loan estimate. This makes shopping for a mortgage particularly frustrating.

Advertised APRs are geared towards certain buyers

Advertised APRs are presented to look exceptionally attractive. That’s why you see so many competitive, low rates on mortgage comparison sites. They’re supposed to compel you to pick up the phone and call a lender.

But advertised APRs are often misleading, because they come with a whole lot of caveats.

Typically the lowest advertised APRs are available only to someone who:

• has a credit score of 740 or higher, plus overall strong finances
• makes a down payment of 20% or more
• plans to occupy the home as their Primary Residence
• is purchasing a property that’s a Single Family Residence
• and has a debt-to-income ratio less than 43%

As you can see, these are pretty big conditions to fulfill to get those advertised APRs. So really, these rates are only available to a small percentage of homebuyers.

Most people don’t put down 20% on a home. In fact, the median down payment for American homebuyers is just 10%. And the less you put down, the higher rate you’ll pay. So keep that in mind as you shop rates.

The bottom line: Those super low APRs you see lenders advertise? They’re not for everyone. Unless you fit the very narrow definition of a lender’s “ideal” homebuyer, you’re probably going to pay a higher APR than the one you see advertised.

To what extent you’ll pay more depends on the lender and your individual situation. That’s why it’s so difficult to compare mortgage APRs.

Always be skeptical of too-good-to-be-true rates when you see them. They’re probably only offered to a few qualified buyers, and subject to pretty heavy limitations.

APRs leave out significant costs and fees

Another reason APR advertisements fall short? A variety of closing costs are left out of their calculations.

Closing costs are one-time fees related to your home purchase that you pay at closing. They tend to add between 2% to 5% to the home’s full purchase price.

But many of these costs aren’t baked into APR calculations. Most lenders only disclose your true closing costs once you’ve applied for a mortgage. And that’s because they’re required to include them in your loan estimate by law.

Note that APRs must include certain lender fees, such as origination, application fees, private mortgage insurance, discount points, and broker and underwriting fees.

However, there are a number of closing costs (mostly third-party fees) that don’t need to be included in APR. But just because these fees aren’t part of your APR, doesn’t mean you don’t have to pay them.

So what are these non-APR fees? They include:

• Property taxes
• Appraisals
• Homeowner’s insurance
• Title insurance
• Pest inspection
• Hazard and flood insurance
• Survey
• Tax escrow
• Credit report
• Notary fee
• Flood inspection
• Attorney fees
• Recording
• Title search

These costs can add thousands to your bottom line. Yet, you’d never know it by looking at a lenders’ advertised APRs. That might be one reason more than half of all homeowners find themselves surprised by closing costs.

What you can do to protect yourself

Your finances aren’t one-size-fits-all, and neither are APRs. It’s crucial to do your research and compare lenders to find the one that best fits your individual financial situation. Here are a few tips:

Look beyond APR

As we’ve noted, APR alone is an incomplete measure of what your home will actually cost, and it’s not the only number you should look at. To get an idea of how much you’ll actually pay for your new home, look at:

• The mortgage interest rate
• Discount points if you’ll be paying them
• Lender and/or broker fees (again, these can be significant — 1 to 3 percent of the loan — and are entirely optional. We don’t charge them.)
• Third-party costs and fees including closing costs, taxes, homeowner’s insurance, etc.
• Private mortgage insurance (PMI) payments if you’ll be making a down payment of less than 20 percent.

Ask what’s included

One way to find out what’s included (and not included) in a lender’s APR? Simply ask. Some lenders may be willing to provide a loan estimate or a clearer idea of what’s included in their APR before you apply.

A caveat: Note that this may not work for every lender. Also keep in mind you’ll likely have to provide some financial details in order for the lender to give you helpful information. Further, understand that giving limited information means getting a limited estimate.

Because your rate and the fees charged depend so heavily on your personal financial picture and the specific home you’re looking to buy, the only way to get a truly accurate estimate of your APR is to submit a complete application to your lender and refer to your loan estimate once it’s provided.

Read the fine print

Never take an advertised rate at face value. Always do a little digging into those terms and conditions before applying for a mortgage.

You might have to click through several pages to figure out what’s actually going on with their “low” rates, but this will give you an idea of the lender’s transparency and trustworthiness.

Apply with multiple lenders

This tip is probably the one true way to get an apples to apples comparison amongst lender APRs. Only when you apply for a mortgage can you get a loan estimate that clearly lays out all of the estimated costs and fees associated with the loan.

We know, we know. Mortgage applications are the opposite of fun. But since this is such a huge financial decision, it’s best to take the time to make sure you have a clear idea of what your options are.

Applying with multiple lenders can ensure you’re getting the best deal, and save you thousands over the life of the loan. Worried about your credit score taking a hit? Don’t be. It’s a myth that your credit score is negatively affected by multiple mortgage applications.

You have 45 days to shop around for a mortgage, and during that period, all of the credit checks mortgage companies run are counted as a single inquiry on your report.

Work with an ethical lender

There is more to a lender than just their rates. The reality is that not every lender is out for your best interests.

There is a massive lack of transparency in the mortgage industry. This is one of the most significant financial relationships you’ll make in your life. So work with a lender that earns your trust and puts you first.

Are they responsive? Do they answer your questions thoroughly and explain each step of the process? Are you able to get in touch with the same representative each time you make a point of contact? These are important questions; just as important as the rate you’ll pay.

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