The Annual Percentage Rate (APR), when combined with the Interest Rate and the loan term, can be used to compare the cost of one loan to the next. This comparison allows the consumer to shop confidently for a loan and a lender that makes the most sense for their purchase objectives. The APR also forces the lender to quantify the fees and charges that it is assessing the borrower for establishing the loan.
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There is something funny going on with the mortgage rate you’ve been quoted. That odd acronym “APR” (Annual Percentage Rate) is showing up in your paperwork and it is not the same as the interest rate you are being quoted. What is going on? Why are there two numbers for your mortgage and which one is more important? Shouldn’t you just care about the rate? The answer is easy. You should be looking at both.
The Annual Percentage Rate includes the true cost of the loan and is required to be shown in any advertised rate quote so that you, the consumer, can make an informed comparison of multiple quotes before choosing a lender.
In fact, while both are important, the APR is probably more important than the rate. Why? The Annual Percentage Rate is the rate that reflects the cost of the loan. Huh? Yep, the cost of the loan. Included in this number are the fees charged to establish the loan. Things like the appraisal, your credit report and any other fees (like Points) that the mortgage lender or bank is charging you for lending you the money to buy your new home or refinance your current home. I know what you may be thinking: “Wait, what? Is the lender charging me to borrow money? Isn’t that what the interest rate is supposed to do?” Not exactly.
You see, the lender has costs that it needs to cover in originating your loan—they are like any other business after all and must make money. They have expenses too, in generating revenue. These expenses can be things like the appraisal, your credit report, the underwriters, and all the other hand labor that it takes to determine your creditworthiness and to process the loan paperwork. The interest rate just covers the time value of money and the premium that the lender makes on lending you the money over the term of the loan. So, they need to pass these other costs on to you. Or do they?
We’ll cover that last question in a later post but let’s first finish the definition of what the APR is exactly. The Annual Percentage Rate includes the true cost of the loan and is required to be shown in any advertised rate quote so that you, the consumer, can make an informed comparison of multiple quotes before choosing a lender.
Here’s how it is calculated:
- Add up all the fees you are being charged for the loan amount to get an Adjusted Balance.
- Find the monthly payment on the Adjusted Balance.
- Return to the original loan amount, and find the interest rate that would result in the monthly payment found in step 2. This is the APR. You can do this easily in a spreadsheet program.
The folks over at TheBalance.com have done a nice job of showing us step-by-step how to calculate APR
So why should we care about the APR? The APR, when combined with the interest rate and the loan term gives us a true picture of what the cost of the loan is over the entire life of the loan. In general, a lower interest rate with a higher APR will result in higher upfront fees but a lower overall cost over the life of the loan. The combination of these variables can be very telling when shopping for a loan. Armed with this information, we can shop for a lender or loan product that meets our specific needs.
Tune in next time when we cover the various loan types (Fixed vs. Adjustable Rate, etc.) that are available and discuss what factors you should consider when choosing a loan product.
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Christian Carr, Mortgage Loan Officer NMLS# 1466899 CMG Mortgage NMLS #1820
About us: Diversified Mortgage Group is a division of CMG Mortgage, Inc. © 2018 CMG Financial, All Rights Reserved. CMG Financial is a registered trade name of CMG Mortgage, Inc. NMLS #1820 in most but not all states. CMG Mortgage, Inc. is an equal opportunity lender, licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act No. 4150025. Offers of Credit subject to Credit Approval. Pleasanton Branch ID#508121. Fremont Branch ID#508123. To verify our complete list of state licenses, please log onto the following website: www.cmgfi.com/corporate/licensing and also www.nmlsconsumeraccess.org. Please contact me at: firstname.lastname@example.org