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2011-03-17
Understanding APR (Actual Percentage Rate)

 

Many of you have heard the term APR (Actual Percentage Rate) when buying a new home, but not everyone actually knows what APR means. APR is more comprehensive than the interest rate that is generally quoted. It takes into account not only the points that you paid to “buy down” the nominal interest rate but also any additional upfront costs (such as closing costs, origination fees, etc.) that you paid.

rate comparasion

 

Here’s how APR is calculated:

First, the nominal interest rate, loan amount, and loan duration are used to determine the actual monthly payment that you will be expected to remit to your lender every month. Then, the loan amount is increased by the additional upfront costs, and the actual interest rate (APR) can be calculated. Because your loan size has been inflated by the closing costs for the purposes of this calculation, your APR will always be higher than your intere

st rate.

 

You can use the APR to compare two loans that have different fixed interest rates and closing costs/points but are otherwise identical.

 

You cannot use APR to compare a variable rate loan with a fixed rate loan because the variable rate used in the calculation will, in reality, fluctuate over time. In addition, you can’t use APR to compare loans of different duration, since allocating the closing costs over a longer time period (30 years instead of 15 years) will automatically reduce the APR. Finally, you can’t use it compare a cash-out refinancing with a second mortgage because the APR calculation doesn’t take into account your existing loan.

 

Having a better understanding of the APR can help you compare two loans that are identical in nearly every respect except for the interest rate and points.

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