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APR Explained

Annual Percentage Rate (APR) is one of the most commonly seen phrases during the mortgage process when comparing loans, as well as with credit cards or auto loans. But what is APR? Is there a difference between the APR and the interest rate? Here is a quick guide to APR and the effects it will have on your mortgage payments each month:

First of all, what is APR?

The best way to explain APR is to compare it with the interest rate. The percentage of the loan that you pay the lender for the convenience of borrowing that loan is the interest rate. This rate calculates your mortgage payment each month without any charges or fees that come with the loan, and it factors in your credit score and loan type. The annual percentage rate (APR), unlike the interest rate, gives the borrower a better idea of what the loan costs overall because it factors in fees charged by the lender like upfront costs, points, and processing fees, spreading out these total costs over the lifetime of the loan to create a new percentage. Because there are more fees included, the APR is normally a higher percentage than the interest rate.

Which costs does the APR include?

Discount points, origination fees, mortgage insurance, and closing costs are all factored into the APR and are usually listed under “finance charges.” APR does not include any homeowner’s insurance or property taxes that are paid through your lender because the bill does not come directly from the lender and the funds you send them are held in an escrow account. Instead, fees the APR includes are charged directly from your lender like the ones listed above.

Why is the APR important?

Understanding the difference between the interest rate and APR can save you thousands of dollars because it easily reveals the overall costs of the loans you are comparing. For example, just because two loans have the same interest rate of 4.7%, doesn’t mean they cost the same overall. One might have an APR of 4.95% while the other has an APR of 5.2%, meaning one has higher closing costs and fees associated with obtaining that particular loan. For another example, perhaps a lender offers a higher interest rate but has much lower closing costs, while another lender has a lower interest rate advertised but increases the closing costs and fees. If you pay less in closing costs, the APR is normally going to be higher, while if you pay more in closing fees it lowers the APR. In the end, a higher APR usually means more that you are paying throughout the lifetime of the loan.

Will I always get the APR that is advertised?

Finding an APR advertised at a low rate is a great start, but your individual rate won’t be decided until your credit is pulled to check your credit score. Borrowers with lower credit scores tend to get higher fees and rates, while someone with a great credit score will normally be charged with much lower fees because they are less risky for the lender to provide a substantial loan for. Once your loan has been vetted, the APR will be sent to you in what is known as a TILA, a “Truth In Lending” disclosure required by law that states your estimated APR.

More About TILA Regulations

It is required by the federal government for lenders to tell all consumers the APR because of the TILA (Truth in Lending Act). This act makes sure credit terms can be easily compared between lenders, so consumers can make the most informed decision when it comes to choosing a loan that is best for them. This was much more difficult to do before TILA since terms and costs were not disclosed in a conspicuous way or even in the same format. After TILA came into effect, all lenders have to use the same rate expressions and terminology so the rates can be easily compared.

Consumers should still look closely at the itemized list the lender includes as the breakdown for what is included in the APR calculation, since some APR’s include certain fees, and some do not. Rates can also fluctuate depending on if you are looking for an adjustable-rate mortgage or a fixed-rate one.

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