WHAT IS AN APR AND WHAT DOES IT REPRESENT?
APR is an acronym for Annual Percentage Rate. This term was specifically designed to help consumers understand the relative cost of a transaction, and to guide them in their search for the best loan.
HOW IS AN APR % DETERMINED
The concept of the annual percentage rate can be difficult to understand because it is based on a complex mathematical formula, which is prescribed in Regulation Z. What is important to understand though, is that the APR is a measure of the "Cost of Credit" expressed as a yearly rate percentage.
The APR reflects the amount being financed, the interest rate, the timing of the payments, and any other costs (prepaid charges) required as a condition of the mortgage loan that make up the finance charge. The finance charge, another required disclosure under the Truth in Lending Act, expresses as a dollar amount the costs associated with the loan, including interest and charges payable by the borrower such as points, loan fees, origination fees, application fees, and insurance, to name a few.
WHAT IS AN EXAMPLE OF AN APR?
When the various components mentioned above are factored together using the APR formula, the APR can be calculated. Because the APR takes into consideration the various fees that are required as a part of the loan, the APR is often higher than the actual rate of interest for the loan.
Type of loan Fixed Rate
Initial Interest Rate 8.000%
Loan Term 30 years
Amount of Loan $90,000
Total Prepaid Charges $2,673.27
WHAT IS THE DIFFERENCE BETWEEN THE INTEREST RATE AND THE APR?
Keep in mind that the APR is an artificial measurement of the relative cost of the loan transaction. It doesn’t have a bearing on the actual rate of interest on a particular loan, but it does take the rate of interest into account. Your loan officer can calculate the APR of various loan programs for you and can explain why these differences between interest rates and APR occur.
Because the APR expresses the overall cost of the loan as a percentage, comparing the APR of a particular mortgage loan with a similar loan is one way to measure the relative cost of the loans. This isn’t the only factor to consider when getting a mortgage loan, but it can be very useful in helping you decide.
Be sure to take into account all of the other information that is provided to you by a lender, including the interest rate and any fees or charges that you may have to pay. Just because an APR is lower on one loan than on other, it doesn’t necessarily mean that particular mortgage loan is the best loan for you.