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What Is Annual Percentage Rate (APR)?
More commonly called APR, Annual Percentage Rate is a government-mandated mortgage comparison tool. It measures the total cost of borrowing over the life of a loan into dollars-and-cents.
A loan’s APR is printed in the top-left corner of the Federal Truth-In-Lending Disclosure, as shown above. When quoting an interest rate, loan officers are required by law to disclose a loan’s APR, too.
APR is meant to simplify the process of choosing between two or more loans. The theory is that the loan with the lowest APR is the “best deal” for the applicant because the loan’s long-term costs are lowest. However, the loan with the lowest APR isn’t always best.
APR makes assumptions in its formula that can render it moot.
First, APR assumes you’ll pay your mortgage off at term, at never sooner. So, if your loan is a 15-year fixed rate, its APR is based on a full 15 year term. If you sell or refinance prior to Year 15, the math used to make your loan’s APR becomes instantly flawed and “wrong”.
Example: Let’s compare two identical loans in Georgia — one with discount points and a lower interest rate; and one without discount points and a higher mortgage rate. The loan with discount points will have a lower APR in most cases. However, if the homeowner sells or refinances within the first few years, the loan with the higher APR would have been the better option, in hindsight.
Second, APR can be “doctored” early in the loan process.
Because the APR formula accounts for third-party costs in a mortgage transaction, and third-party costs aren’t always known at the start of a loan, a bank can inadvertently understate them. This would make the APR appear lower than what it really is, and may mislead a consumer.
And, lastly, APR is particularly unhelpful for adjustable-rate loans. Because the APR calculation makes assumptions about how a loan will adjust during its 30-year term, if two lenders use a different set of assumptions, their APR’s will differ — even if the loans are identical in every other way. The lender whose adjustments are most aggressively-low will present the lowest APR.
Summarized, APR is not the metric for comparing mortgages — it’s a metric. For relevant comparison points, talk to your loan officer.
The Simple Explanation Of APR
Posted by Chad Lariscy on November 18, 2009 | Comments (0) | Tags: Conforming Loan Limits
APR is an acronym for Annual Percentage Rate. It’s a government-mandated calculation meant to simplify the comparison of mortgage options.
A loan’s APR can always be found in the top-left corner of the Federal Truth-In-Lending Disclosure.
Because APR is expressed as a percentage, many people confuse it for the loan’s interest rate. It’s not. APR represents the total cost of borrowing over the life of a loan. “Interest rate” is the basis for monthly mortgage repayments.
The main advantage of APR is that it allows an “apples-to-apples” comparison between loan products.
As an example, a 5.000 percent mortgage with origination points and fees will almost certainly have a higher APR than a 5.500 percent mortgage with zero fees. In this sense, APR can help a borrower determine which loan is least costly long-term.
However, APR is not without its shortcomings.
First, different banks includes different fees into their APR calculations. By definition, this spoils APR as a choose-between-lenders, apples-to-apples comparison method.
And, second, when calculating APR, “life of the loan” is assumed to be full-term. When a 30-year mortgage pays off in 7 years or fewer — as most of them do — APR comparisons are rendered moot.
In other words, APR is just one metric to compare mortgages — it’s not the only metric. The best way to compare your mortgage options is to review all the loan terms together and determine which is most suitable.
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