Episode # 26 of the Mortgage Foundations Podcast
For many homeowners and potential homeowners, one of the first questions that comes up when shopping for a mortgage is "what is the interest rate on my mortgage?". Of course, the interest rate is important; however, even more important is the Annual Percentage Rate, or APR, since this is where you find the true cost of borrowing the principal amount of your mortgage.
Mortgage Brokers are regulated to not only inform the client of their interest rate on their mortgage; but, we also need to disclose the Annual Percentage Rate to the client in both rate format and in dollar terms as well. This ensures that clients have full clarity on the true cost of borrowing for their mortgage.
So, what is the difference between an interest rate and an Annual Percentage Rate?
The interest rate is used to calculate the actual amount of interest you will pay on the principal of your mortgage over your term and only includes interest to be charged. It is essentially the cost of borrowing money over time. Let's say your mortgage is $500,000 and your interest rate is 5%. For simplicity, we will use a 1 year term for our examples and ignore amortization. In this case, the interest cost for this mortgage would be $25,000, which is 5% of $500,000. This calculation is simple enough and includes the interest cost; however, there are usually other costs involved with a mortgage and this is where the Annual Percentage Rate comes into play.
The Annual Percentage Rate is a broader measure of the cost of borrowing and not only includes the interest cost but also other costs and fees associated with obtaining the mortgage. These can include closing costs, lawyers' fees, tax on mortgage default insurance, and lender or broker fees on mortgages where these are applicable. Using the same example as before, let's say that closing costs and lawyers fees were $5,000. In order to calculate the APR we add the interest cost and the other fees together to get a true cost of borrowing of $30,000 or 6%.
It is important to note that the 6% calculated for the Annual Percentage Rate is not what will be used for your actual interest cost; that will be the interest rate that you agreed to with your lender, in the previous case, 5%. The Annual Percentage Rate provides a more accurate picture of what the mortgage actually costs you and annualizes the fees for full transparency.
The Annual Percentage Rate is not specific to mortgages and are also found on credit cards and other loans since those creditors also need to provide the full cost of borrowing money from them.
Paying attention to the Annual Percentage Rate when comparing mortgage products is important since ignoring it could make two similar mortgages at 5% seem like they are equal; however, if one of those lenders is charging a 1% lender fee, they are not equal at all; this is the reason why Mortgage Brokers are regulated to provide the Annual Percentage Rate to you. In fact, our regulator, the Financial Service Regulatory Authority of Ontario, pays a lot of attention to how Mortgage Brokers are disclosing this to clients and lately have been finding that some Brokers are not properly including all costs in order to present a lower Annual Percentage Rate to their clients to hide the true cost of borrowing. These findings are being met with large penalties and even the suspension or loss of the Broker's license. Always ensure that you are being made aware of the total cost of your mortgage.
In conclusion, the Annual Percentage Rate of a mortgage is different from the interest rate and includes the interest cost for the mortgage, as well as all fees and costs incurred to obtain that mortgage.