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Why mortgage APRs are virtually useless

Katie McMahon 23 October 2015

When you're looking for a mortgage, you'll always be able to see the APR (annual percentage rate).

Regulation requires that we publish the APR and give it equal prominence to the initial rate and standard variable rate (SVR). APR is referred to as the "Overall Cost For Comparison", so you think it'd be the best thing to look at when comparing different mortgages.

You'd be wrong.

In practice, it's totally out of step with the way mortgages work in real life.

To understand why, let's look at how APR is calculated, and what assumptions are made.

(And in case you're worried this is all bad news, I'm going to propose a better way to compare. )

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The APR assumes you'll stay the whole term

When you take out your first mortgage it's usually for 25 years or more, but it's also usual to set up the deal as a fixed rate or tracker for a certain period of time (e.g. 5 years). So what happens after this rate expires?

  • If you do nothing, your mortgage reverts to your lender's Standard Variable Rate (SVR), which can change at any time and is usually a lot less competitive than the introductory rates on offer.
  • In practice most homeowners look to remortgage and find a better deal, in time for when their introductory rate expires.

The APR doesn't take this behaviour into account, because of the way it's calculated. You see the APR averages out the interest rate for the full term.

Say you're looking at a 25 year mortgage fixed for five years. You care most about what you're going to pay over the next five year period: you don't intend to stay on an uncompetitive rate for the next 20 years.

In this case the APR is five years at the rate you want, and 20 years at a rate you don't.

You might of course end up trapped on your lender's SVR, and for this reason the APR can be a useful figure to have in mind – although it's not so much a "cost for comparison" as a "worst case scenario".

The APR assumes the variable rate won't vary

Here's the thing about the Standard Variable Rate: It can vary.

But the APR calculation has to be based on something. It's impossible to predict the future, so it can only go on the SVR as of today.

This means that when you look at an APR you are looking at a figure cobbled together on the assumption that a lender's SVR today won't change until the end of the mortgage term.

Is this a fair assumption?

Judge for yourself: in March 1990 the average SVR was 15.23%. Twenty-five years later in March 2015, it was just 3.56%. If you'd been on your lender's SVR for a whole mortgage term, you would have been on quite a roller-coaster ride of rates!

So as we've seen, calculating the APR involves making two assumptions which are shaky at best:

  • You'll stay with the same deal for the duration of the term
  • The lender's SVR won't change for 25 years

So let's look at a more useful way to compare mortgage deals.

How to (actually) compare mortgages

When you're comparing mortgages there are two things you need to take into account.

Look at the true cost

As we explained in detail in this article, it's important to work out the true cost of a particular mortgage deal, over the period that you'll be sticking with it.

Don't forget the fees

Decide whether you want to prioritise overall cost or short-term savings (if you're moving house, you may want to minimise your upfront cost), and compare deals with fees vs no fees.

Hopefully you've now got a thorough understanding of the calculations and assumptions behind the APR. With this in mind, compare today's best rates and see whether you could save on your mortgage.

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