What is the difference between an interest rate and the annual percentage rate you get on a VA mortgage? There IS a difference and knowing what each of these two things mean will help you make a more informed decision about your mortgage.
VA Home Loan Basics
Before we start looking at the APR and interest rate issues on a VA mortgage, it’s a good idea to understand a few basics about VA mortgages that apply in this area. The interest rate and APR are things you will negotiate with the participating VA lender.
The Department of Veterans Affairs does not set or regulate APR or interest rates except in a general way with the requirement that these are set according to what is considered to be “reasonable and customary” for a home loan in that housing market and the conditions under which you are applying for the mortgage.
You won’t find the VA publishing interest rates, APR information, or other data–that is something you will need to research with each participating VA lender.
Furthermore, VA loans, like all other mortgages, will have interest rates that are generally lower than many conventional mortgages, which is due to the government’s guarantee for a portion of the VA mortgage. Lower risk means better interest rates, and that is something that applies to you in more ways than one.
If you have higher FICO scores and a solid credit history, you will be offered a more competitive interest rate than if you come to the VA loan application process with a lower credit score, missed payments, etc.
We say all this to remind borrowers that interest rates are affected by credit history and if you take additional time to work on your credit ahead of your mortgage loan application you will likely be offered a more competitive rate.
Defining The Interest Rate
Your VA home loan interest rate is what your loan costs over the lifetime of the mortgage. You will be offered an interest rate, which you can multiply by the amount of the loan multiplied by the percentage of the interest. The amount you get is the interest you would pay on that loan for the year.
A $200,000 loan charged four percent interest would cost $8,000 per year. You can divide $8,000 by 12 to see how much the loan costs per month. You can multiply $8,000 by the term of the VA mortgage (15 or 30 years in most cases) to see how much you will pay in interest over the entire term.
When you shop around for a VA mortgage, you will find each lender lists an interest rate for that day’s mortgage loans. The rates are subject to change, and can change daily, or even more often depending on market conditions.
But you should keep in mind that the advertised interest rate is not necessarily the rate you will be offered by the lender. This is because the advertised rate assumes “best execution,” or a home loan application from an extremely well-qualified borrower (financially speaking). Your experience WILL vary depending on your credit and other issues.
That is why some borrowers are disappointed in times when rates are low–they assume rates are lower for EVERYONE, and that isn’t always true for those coming to the VA loan process with past credit problems that show credit management patterns the lender might decide are a bad risk.
What is the APR? The acronym is short for Annual Percentage Rate, and this rate is indicative of the actual cost of your VA mortgage.
Investopedia explains that a big difference between the APR and the interest rate is that the APR includes all costs of the loan including closing costs, fees, and the interest rate itself. So while the interest rate describes a specific aspect of how much your loan will cost and why, the APR includes the interest, but also the other expenses. Any broker fees, closing costs, discount points, and other expenses will be factored in.
Let’s assume that all VA loan fees are added together and you get a figure of $5,000 for those fees. And let’s also assume that the cost of the home you wish to purchase or build using a VA mortgage is $170,000 and you’ve been offered an interest rate of 5%. To arrive at the APR, you will need to add the sale price of the home or the appraised value of it (whichever is lower) to the amount of the costs.
If the home is $170,000 and the fees are $5,000, the total amount would be $175,000. You take that total and calculate the annual cost of the loan for the year (see above) and then divide the annual cost of the loan by the amount of the sale price or appraised value, which ever is lower. The figure you get is the APR.
$170K x the interest rate (5%) = $8,500 per year
$170k + loan fees ($5000) = $175,000. This is the “new loan amount”
$175k x the interest rate (5%) = $8,750
$8,750 / $170,000+ 5%
Things to remember about the APR include the fact that fees and expenses may be spread out (payment-wise) over the lifetime of the mortgage. That means that a refinance loan could make your mortgage more expensive than the APR leads you to believe–this is true because the APR is calculated assuming certain costs will be paid over the lifetime of the mortgage which is defined as your original loan term.
Cutting the loan term short by refinancing or selling the property will naturally change how much your loan actually costs over the time you paid on it. Furthermore, APR data is less hard-and-fast for mortgages with adjustable interest rates since there is no single rate applied over the entire lifetime of the mortgage.
You will need to ask your VA lender to show you how your loan cost will vary over the duration of an adjustable rate mortgage if you aren’t sure how to adjust for the inevitable mortgage loan interest rate adjustment periods built into the mortgage. Fixed rate mortgages do not have such interest rate adjustments, hence it is easier to determine what the loan will realistically cost over the entire term.
Joe Wallace is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News
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