What is the Difference Between Interest Rate & APR on a VA Loan?
When you first start exploring a VA home loan, chances are there will be a few new financial concepts to learn. Unless you’ve taken out a mortgage before, terms like APR and interest rates can seem confusing at first glance. The good news is that with just a little bit of research, you can clarify these elements and be a more empowered home buyer.
Many new borrowers mix up Annual Percentage Rates (APR) and interest rates. Although every home loan can be measured by these two rates, there are key differences between them. In a nutshell, the interest rate is the amount that the lender charges to borrow the principal balance. The interest rate is always the focus of the conversation and is published on the NOTE, which is part of the final loan documents. Alternatively, the APR is a measurement of the cost of credit or cost of the loan and is almost always higher than the NOTE rate. Annual Percentage Rates or APRs must be provided by all creditors lending money, including revolving credit and installment loans, as well as mortgages. Now that we mention it, you’ve seen APRs before on car loans and credit cards, right?
To understand the basics of interest rates and loan payments, let’s see an example of them in action. If you took out a $300,000 30-yr VA home loan at a rate of 6.00%, your interest costs would be $18,000 per year, or $1,500 a month. However, because there is a principal reduction, known as amortization, in every payment, your principal and interest payment (P&I) would be $1,798.65. There are a variety of factors that affect what your interest rate will be, including your credit score and debt-to-income ratio. There are also wider economic factors that affect what mortgage rates are countrywide.
Now, let’s tie it together, by demonstrating the APR. When you’re comparing home loans, it can be important to consider the APR. Included in the APR will be the calculation of the appropriate fees to get the loan. Not all loan closing costs are included when calculating the APR. Included fees are the VA funding fee, appraisal fees, origination charges, title charges, discount points, and credit report fees. These expenses can be rolled into the loan amount on a VA refinance loan, but not on a VA purchase loan. In either VA loan type, the APR would still be the same.
To build off of our previous example, if we had a $300,000 loan and $6,000 in closing costs, that would mean a total loan of $306,000. Now, we apply our 6% interest rate to get a new monthly principal and payment of $1,834.62 – again, a 6.00% NOTE rate.
The easiest explanation of how to arrive at the APR for the $300,000 loan is to answer this question: “What would the ‘interest rate’ be for a 30-year $300,000 VA loan that has a payment of $1,834.62 ?” The answer equals 6.186%. You didn’t want a VA refinance loan at $306,000 or a VA Purchase loan at $300,000 with $6,000 in costs, you just wanted to borrow $300,000, right? But on the refinance, your loan balance went up to cover the costs, arriving at a payment of $1,834.62, with a NOTE rate of 6.00% and an APR of 6.186%. Again, the APR would be the same on a VA purchase loan. The refinance is an easier explanation!
If these numbers didn’t click right away, don’t sweat it. The main takeaway is to consider the APR when shopping for a home loan, rather than just focusing on the VA loan rates. Your lender will walk you through all of the costs associated with a home loan before you buy. Have questions about APR vs interest rates or any other aspect of the VA loan? Reach out to a SoCal VA Homes VA home loan expert directly at 949-268-7742!