What is Annual Percentage Rate (APR)

  • By Admin
  • October 11, 2013
  • Comments Off on What is Annual Percentage Rate (APR)

APR

There are many costs associated with taking out a loan.  The interest rate is one of those costs.  There are also charges, such as application fee, underwriting fee, and points that the bank may charge, to name a few.  If a loan has no additional fees and charges, in other words, the interest is the sole cost of borrowing, then the APR is the interest rate.

When presented with multiple loan offers from various banks, how does one know which is best?  Lets say one bank offers  a house buyer a 30-year fixed-rate mortgage loan with an interest rate of 4.25% with 1 discount point, meaning the borrower pays the bank 1% of the loan amount at closing in order to get the 6.25% interest rate, and another offers a loan with 4.5% interest rate and zero point, how would the borrower know which to choose?  Without taking into consideration the borrower’s financial situation such as his cash reserves situation and how long he intends to live at the property, the loan with the lower APR is the better choice.

It is quite common to see one loan with a lower interest rate but higher APR than another.  That signifies the lower interest rate loan has a higher total borrowing costs throughout the entire loan term.  That is not to say that loans with the higher APR are bad.  For home buyers who will not keep the loan the entire term, the APR is less important.

So what are some of the loan fees that are included in calculation of the APR?  Origination and discount points, prepaid interest, private mortgage insurance (PMI), and any lender fees such as processing, underwriting, credit reports, application fees, tax service fees and administrative fees are all used to calculate the APR.

The APR is found on the Federal Truth In Lending Disclosure Statement, a disclosure form that is required by law to be given to potential borrowers. Because the APR takes into considerations all the bank fees a lender charges, it is a good tool to compare different loan offers.

For a credit card, the APR is generally the same as the interest rate.  The APR of a home mortgage is almost always higher than the interest rate due to closing costs.

For an adjustable-rate mortgage, the APR assumes the loan’s index doesn’t change from its initial value.

The APR does not affect the monthly payments.  Monthly installments are calculated based on the interest rate, or the Note rate.

APR (Annual Percentage Rate) should only be used to compare similar loan programs on an identical loan amount. The APR on a 30 year fixed loan should not be compared with an adjustable rate mortgage.  Also, identical loan programs and rates will have different APR’s depending on the loan amount. For example, the APR will be lower on a $250,000 loan than on a $150,000 loan using the same interest rate.

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