by Patricia Adkins
When you are in the market to purchase a home or refinance an existing loan, understanding the difference between the interest rate that was quoted to you and the actual APR is crucial. If you consider only the interest rate, you can easily end up spending more money than you expected. Here is a guide to understanding the difference between the two.
The acronym APR stands for Annual Percentage Rate, a term that was created by the government as a standard for all lenders. Lenders must disclose the APR as well as the interest rate to loan applicants so that people applying for a loan can accurately compare rates. Many people do not fully understand the difference between interest rates and APR and therefore choose loans based on interest rates only.
The interest rates that lenders use to attract customers differ from the actual cost of the loan. The interest rate is the amount that a financial institution will charge you for allowing you to use their money. The interest rate is only applicable on the principal, or original, amount of the loan.
The APR takes into account many of the fees and charges that may accompany your loan. Examples of these charges may be points, PMI or private mortgage insurance, prepaid interest, closing costs, and others. It is the amount of interest you will pay on a yearly basis after all of the interest and charges are figured in, and represents the total cost of credit on a yearly basis after all charges are taken into consideration
The APR can be confusing because companies do not calculate the APR the same way. Although Federal law requires lenders to disclose the APR, it does not specify what must be included and how it is to be calculated. As a result different lenders include different things. It is wise to inquire what is included in the APR before making a decision. This way you can get a true comparison between prospective lenders.
Keep in mind that while the APR is going to be higher than your interest rate, it should not be too much higher. Beware of annual percentage rates that are significantly higher than the quoted interest rate, this means that there are hidden fees. Look at all the terms before you agree to a loan.
It is more important to compare the APRs on different loan options than it is to compare the interest rates. The APR more accurately represents the actual cost of your loan and is the rate that your monthly payment will be calculated based on. The APR will vary based on the length of the term, for instance a fifteen year loan will have a higher APR than a thirty year loan, but you will ultimately pay less interest on a fifteen year term.
The APR does not represent any variables like prepayment penalties or balloon payments. It is important for you to do your research when looking for a new loan and understand all of the terminology associated with the loan. Having a good understanding of the difference between the interest rate and the APR is a good place to start. APRs, although inconsistently calculated, can be a very useful guide in choosing your loan, but it is wise to consult a mortgage professional to help you find the best loan for your situation.
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