APR Defined: Your Simplified Guide to Annual Percentage Rate
- posted 6.4.2013
- Ashley Bailey
- Home Loans
How to explain APR
What is an APR? APR stands for annual percentage rate. Annual percentage rate can sound daunting, but in the simplest terms APR is the combination of two things: the interest rate of the loan, plus lender fees and closing costs. Lender fees vary and may include appraisal fees, underwriting fees, processing fees, etc. Closing costs can include closing fees, insurance fees, taxes, and prepaid interest.
The APR reflects the true cost of borrowing, over the course of one year, hence the word annual. It is important to grasp the concept of APR because it is a great way to compare lenders side by side! Lenders are required by law to disclose both the interest rate and APR, so you get the real picture of what you will be paying over the life of the loan.
Interest Rates vs. APR
Interest rate is the annual amount charged for taking out a loan, expressed as a percentage of the principle, but does not include lender or closing costs, or any other additional fees.
APR is the annual amount charged for taking out a loan, expressed as a percentage of the principle, including any lender or closing costs, and any other additional fees.
Although lender fees and closing costs are often built into the APR, they are in reality fees paid up front. However, the APR mathematical equation assumes that the fees are paid over the life of the loan in the same manner as the interest rate.
Aside from lender fees and closing costs, there are some other factors that can play a role in determining the APR associated with your loan. For example, discount points. Discount points are optional. They can be used to lower your monthly payment by buying down your interest rate. Think of a discount point as a way to pre-pay some interest you may accrue on the loan. One point is equal to one percent of the loan. For example: a loan that is $100,000 would have 1 point equaling $1,000. In the long run this helps the borrower have a lower monthly payment, and the lender gets an up-front payment on the loan. Beware of the fact that buying too many points may not always benefit you, take a look at the cost analysis before deciding on points, if you decide to go that route. Discount points are also tax deductible which may be appealing for some borrowers.
Other Factors That May Affect APR
There are many other factors that may affect the APR–Some lenders choose to include these fees while others do not. Make sure you find out what is factoring into the APR a lender is presenting.
Factors that are typically included in the APR:
- Discount points
- Processing fees
- Mortgage Insurance
- Appraisal fee
- Credit report fee
Factors that are not typically included in the APR:
- Title or abstract fee
- Escrow fee
- Attorney fee
- Notary fee
- Document preparation
- Home inspection fees
- Recording fee
- Transfer taxes
Make sure you understand that time/life of the loan plays a huge factor when you are comparing lenders and APR's side by side. Also, different lenders have different fees that are factored into their APR's. Make sure you take note of which fees are already calculated in and which are not. The Truth in Lending Act ensures that every lender has to be up front and disclose all fees to any potential borrower. You also want to make sure you're not overpaying in lender fees. Do your research and ask your lender questions. They will break it down with you to make sure everything looks good for your loan.
Example of a calculated APR:
Loan Amount: $200,000
Interest Rate: 5.90%
30 Yr. Term (in months): 360
Closing Costs: $2,000
Loan Amount: $100,000
Interest Rate: 6.3
30 Yr. Term (in months): 360
Closing Costs: $1,000
To calculate your own APR, please visit eHow.
Remember that APR is not the only thing to look at when deciding on the right loan for you. The interest rate, points, fees and the MI (mortgage insurance) should also be considered before making a decision. Take a look at the loan options New American Funding has to offer here.