What is APR (Annual Percentage Rate)?
The Annual Percentage Rate (APR) represents the true annual cost of borrowing money. While an advertised interest rate only accounts for the interest charged on the principal loan balance, the APR includes all upfront lender financing fees, mortgage discount points, appraisal charges, and origination expenses.
Interest Rate vs. APR: Key Differences
| Feature | Nominal Interest Rate | Annual Percentage Rate (APR) |
|---|---|---|
| What It Measures | Cost to borrow principal balance only | Total cost of credit (Interest + Upfront Fees) |
| Used To Calculate | Your monthly principal & interest payment | True comparison between competing lender loan offers |
| Relative Value | Always lower than or equal to APR | Higher when upfront fees or points are charged |
How APR is Calculated (The Internal Rate of Return)
The APR is calculated by finding the discount rate ($r$) that equates the net loan amount received ($P_{net} = ext{Principal} - ext{Financing Fees}$) to the present value of all future monthly loan payments ($M$):
What Fees are Included in Mortgage APR?
- Loan Origination & Processing Fees: Underwriting and administrative charges.
- Discount Points: Upfront prepaid interest purchased to lower the note rate.
- Mortgage Broker Fees: Intermediary finder fees.
- Private Mortgage Insurance (PMI): Required when down payment is less than 20%.
Frequently Asked Questions
Why is my APR higher than my interest rate?
Your APR is higher because it amortizes upfront closing costs and financing fees over the full term of the loan, giving you the true annual cost of credit.
How do discount points affect APR?
Paying points lowers your monthly interest rate but increases your upfront closing costs. If you keep the loan for its full term, paying points can lower your overall APR.
Should I always choose the loan with the lowest APR?
Generally yes if you plan to keep the loan for the full term. However, if you plan to sell or refinance in 3-5 years, a loan with lower upfront fees and a slightly higher APR may save you more money.
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