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What is APR?

December 30th, 2017 4:49 AM by Jackie A. Graves

When shopping for a mortgage, you’ve most likely seen the phrase “annual percentage rate” or “APR” advertised, just like you would for a credit card. But not everyone understands what an APR is, or knows how it’s different than an interest rate. And it can make a difference in your home loan search. Here’s a look at what an annual percentage rate is and how it affects your monthly mortgage payment.

What is APR?

When understanding what the APR, or annual percentage rate is, it’s important to understand how it compares to the interest rate you’ll pay for your mortgage. The interest rate is the percentage you will pay to borrow the money for your home. This rate does not reflect fees or any other charges associated with the loan, but calculates what your actual monthly mortgage payment would be.  The interest rate you pay depends on factors like your loan type and credit score.

The annual percentage rate, however, reflects the true and total cost of the loan. It factors in the interest rate plus any upfront costs and fees that are charged by the lender to obtain that rate or to close the loan, such as points, fees, or other costs associated with the loan.

The annual percentage rate, usually shown next to the advertised and called “APR”, or nominal, interest rate, is always higher than the actual, or effective, loan interest rate because it annualizes the fees and costs associated with the loan. The APR is the yield to maturity on all the finance charges the borrower pays. And it provides a more complete picture of the annual cost of your loan.

Understanding Your Annual Percentage Rate

Knowing the annual percentage rate can help you compare different loans among lenders, and possibly save thousands of dollars. Even if different lenders are advertising the same interest rate, of say 4.5 percent, the APR of one might be 4.85 percent and of another 5.1 percent – simply because it has higher fees and closing costs to obtain that loan. Alternatively, one lender could offer a higher interest rate with lower costs, possibly making it a better loan than one with a lower advertised interest rate and higher associated costs.

The higher the APR, the more you’re going to pay over the life of the loan. Consider that the less you pay in closing costs the more likely it is that the APR will be higher; whereas the more you pay in closing fees the APR will be lower.

What Is Included?

Fees and costs that may be bundled into the annual percentage rate are the origination fee, discount points, closing costs and the cost of mortgage insurance premiums. These fees are often referred to as finance charges, although there may be other fees that help constitute the APR that are not listed under finance charges.

If you pay your property taxes or homeowners insurance through your lender because the payments are held in escrow, these are not part of the annual percentage rate because these are not charges being billed to you by the lender. The lender is just collecting those payments on behalf of the county or representing agency.

Advertised vs. Actual

Although you may see a great advertised annual percentage rate, your actual annual rate is not determined until your loan is vetted with the lender’s underwriter. This is because the lender might charge higher fees for someone with a lower credit score than someone with near perfect credit. They’ll have to run a credit report to see what your actual credit score is. Typically, the higher your credit score, the lower interest rate. Learn more about credit scores here.

Your estimated APR is disclosed to you through a Truth in Lending document known as TILA. This APR is considered final once you have locked in your interest rate.

When a Higher Rate Might Be Better

There are occasions when a loan with a higher annual percentage rate would be cheaper than one with a lower APR.

Since a high APR typically has a lower the interest rate, you might consider that option if the seller of the property is paying the closing costs for you, without rolling the costs into the purchase price.

For example, say you offered $210,000 on a home listed at $215,000, and the seller agrees to pay your closing costs. Since the money for the closing costs is not extra cash you have to bring to the table, but is money the seller will pay at closing, a loan with a low interest rate and higher APR – costs and fees – might be more beneficial to you than one with a higher interest rate and low APR.


For consumer protection, the federal government requires that all lenders notify you of the annual percentage rate. This is done through the Truth in Lending Act (TILA).

TILA ensures that credit terms are disclosed in a meaningful way so consumers can easily compare credit terms to make an informed decision about the best loan for their needs.

Before TILA’s enactment, consumers found it difficult to compare loans because they were not presented in the same format. Now, all creditors must use the same credit terminology and expressions of rates, so consumers are able to look at the annual percentage rate as a point of comparison. However, for the best comparison, consumers should still look at an itemized list of what fees are incorporated into that APR. For example, one lender may count courier fees and another does not.

Additionally, your annual rate might also be different if you are requesting a primary home mortgage, are refinancing or taking out a loan for an investment property. Your annual rate might also be different if you take out a fixed-rate mortgage or an adjustable-rate loan since the federal government regulates these loans differently.

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Posted by Jackie A. Graves on December 30th, 2017 4:49 AM


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