When choosing a conventional mortgage or a government-backed loan in Albuquerque or Santa Fe, you should pay close attention to the annual percentage rate (APR). It is not to be confused with the interest rate, which indicates the cost to borrow money from a mortgage lender per year.

The APR is a much more accurate representation of the overall cost of your debt. In addition to the interest rate, its calculation factors in the closing costs and other fees you need to pay to process the real estate transaction.

While the APR can tell you how cost-effective a loan program is, it is not 100% reliable. Here’s how mortgage APRs can mislead you:

They Usually Do Not Include Third-party Fees

As mentioned, the APR includes the interest rate and a host of fees into the equation. It can help reveal the real amount of money you can borrow since not every single penny a mortgage lender gives you can be used to buy your prospective property.

Out-of-pocket expenses diminish the borrowed funds without shrinking the size of the principal. It is possible that a loan with a higher interest rate but with a lower APR can be more cost-effective than one with a lower interest rate but with a higher APR since the interest does not comprise your total cost of borrowing.

Generally, what lenders use to calculate mortgage APRs are the fees they charge themselves. Underwriting, processing, and document drawing fees are some of them.

More often than not, you have to pay fees charged by third parties. These costs can include title, notary, escrow, and home inspection fees. The APR can’t reveal the real value of your debt unless you find how much third parties charge for the service they provide early on and do the math yourself.

They Usually Expect that the Loan Will Fully Mature

Another limitation of the APR is the assumption that the borrower keeps the mortgage for the full term. An average New Mexican does not let the loan run its course. A mortgage is paid off ahead of schedule because a homeowner applies for a refinance or moves and sells the property.

The less time you keep your mortgage, the higher its APR becomes. A classic example is when you buy down your mortgage interest. Purchasing discount points increases the loan’s APR, but you could reap the benefit of doing so only if you stay put long enough. If you decided to pay off your mortgage early, you would end up spending more on interest.

They Usually Assume that the Fully Indexed Rate Goes Down

A conceptual look at variable mortgage rates.

When it comes to adjustable-rate mortgages (ARMs), the APR is calculated with the assumption that the fully indexed rate goes down upon adjustment. If you take out an ARM and your interest rate increases when the fixed-rate period is over, the real APR of your loan naturally goes up.

In the end, APRs are more accurate than interest rate as far as painting the picture of the cost of borrowing is concerned. However, they can be considered merely estimates, so take them with a grain of salt.