Understanding APR, Monthly Interest Rate
Mortgage interest rate, annual interest rate (APR), base rate – what do they mean and which one is more important? Learn how to understand and evaluate a mortgage offer.
The interest rate on a loan is the indicator by which offers for home loans are most often compared. No wonder, because it describes the price of the loan. The borrower lends money to buy a house. The lender sets a price or interest rate for the opportunity to use the money. Thus, the borrower needs to repay both the principal and the interest calculated from the base price.
How is the interest rate determined?
First of all, the lender sets a base rate – an interest rate that indicates the price of the money borrowed. To determine it, special money market indices are used. As the index value changes, the base rate also changes. The loan agreement fixes how often the base rate is revised in accordance with the market situation (for example, every 6 months).
Since the repayment period of mortgages is usually long (up to 30 years), the lender also calculates a “price” or added rate for the various risks that may arise during the entire loan period. The risks for each borrower will be different. This rate is usually fixed and does not change anymore (this depends on each lender, since this rate can be set as an added one for different lenders and regularly revised).
The final mortgage rate is calculated by adding the base rate and the add-on rate, which will be individual for each client. For example, if at the time of contract signing the six-month index used as the base rate is 0.5% and the borrower’s individual rate is 3.0%, then the total loan rate will be 3.50%. When evaluating an interest rate proposal, you should pay attention to both types of rates. It is necessary to assess not only their value at the time of the proposal, but also the impact of the rate change on the monthly payment in the future. Each lender determines interest rates and risks himself and develops his own credit recommendations. For example, DMC is a player in the international financial market, therefore it uses the generally recognized recommendations of international rating agencies.
Annual percentage rate or APR
APR is a standardized informative indicator introduced for the purpose of consumer protection. With its help, all costs associated with registration and repayment of a loan are expressed in the form of an annual interest rate so that the borrower can objectively compare loans provided by different lenders.
When calculating the APR, it takes into account both the interest rate on the loan and monthly payments, as well as the registration of a loan or commissions, current accounts, paperwork and other costs, and the duration of the loan agreement, i.e. positions that may vary for each lender. Most of these costs are related to loan processing and do not affect monthly payments. Therefore, this figure should not be taken as a “real” interest rate. If the APRs differ for different lenders, you should not be afraid, but you can find out in more detail what costs are included.
Can the interest rate be changed?
The usual practice in the banking industry does not give the borrower the ability to influence the interest rate on the loan. The lender calculates the rate at the time the loan is issued and it remains unchanged. The borrower may be asked to lower the rate based on “loyalty” – if the borrower commits to purchase extra financial products (credit card, life insurance, opening a billing account, etc.). However, this practice cannot be considered ethical in relation to the consumer, since instead of a home loan, another, combined product will be offered.
Understanding APR is an important metric when comparing mortgage loan offers. However, it doesn’t have to be the only one. We invite you to carefully read all the terms of the agreement, evaluate the attitude and professionalism of the lender, as well as critically evaluate the “loyalty” proposals. Often the interest rate does go down, but due to the rest of the purchased financial products, the total monthly payments do not change, but even increase.