The annual percentage rate (APR) is an interest rate commonly used to compare the loan programs offered by different lenders. As per the laws in Federal Truth in Lending Act, every mortgage company is required to disclose the APR when they advertise their rates.

Example:

30-year fixed

8%

1 point

8.107% APR

This APR will not have any affect on your monthly payments. Your monthly payments are set on the basis of the interest rates and the length of the loan.

APR is designed to measure the true cost of the loan. Sometimes, lenders don’t show the actual rate of the loan and they tend to charge any hidden fees after the loan is granted to the consumer. APR helps to understand the actual cost of the loan and stop lenders from advertising a low rate or any hiding fees in the beginning.

Every lender calculates APR in their own way. So a loan with a lower APR may not be the best deal that you have got from the market. The best way to compare loans will be to ask lenders to provide you a good faith estimate of the actual costs on the same type of program at the same interest rate. then you can subtract all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. The lender that has the lower loan fees is cheaper than the lender who charges high fees.

In most of the cases, it’s pretty hard to compute APR because the fees are actually not well defined. Go through the fees mentioned below.

These are generally included in the APR:

• Points – both discount points and origination points
• Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
• Loan-processing fee
• Underwriting fee
• Document-preparation fee
• Private mortgage-insurance

The following fees are SOMETIMES included in the APR:

• Loan-application fee
• Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)

The following fees are normally NOT included in the APR:

• Title or abstract fee
• Escrow fee
• Attorney fee
• Notary fee
• Document preparation (charged by the closing agent)
• Home-inspection fees
• Recording fee
• Transfer taxes
• Credit report
• Appraisal fee

An APR will not tell you the duration for which the rate is locked. A lender offering 10 day rate lock might have a lower APR than another lender who offers a 60 day rate lock.

Never compare a 30 year loan with a 15 year loan using their respective APR. A 15 year loan may have a lower interest rate but the APR might be set high because the loan fees are amortized over a shorter period of time.

Sometimes, even the lenders are not certain about the APR they are charging on the loans. There may be different results on calculating APR because of using different software programs to compute the APR.

APR is a very complex calculation and not clearly defined. Always get a good faith estimate from the lenders and compare the costs. And make sure that you exclude those costs that are independent of the loan.

This entry was posted on Friday, January 4th, 2008 at 7:33 am and is filed under APR, Loan, Mortgage, Personal Finance. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.