What is annual percentage rate (APR )?
When a borrower receives a quote on a mortgage or credit card. she may receive two interest rates. The first rate indicates the amount of interest she will pay on the loan. The other number, the annual percentage rate, or APR, indicates the rate she will pay on the loan plus the costs associated with the loan, for an entire year.
When a mortgage lender quotes you a rate, it will provide an interest rate. Rates on loans are either variable or fixed. Interest rates are quoted as a percentage. For example, a mortgage loan may be quoted at 4.5 percent. This amount reflects the interest rate the borrower will pay on the money they borrow from the lender.
APR is also quoted as a percentage; however, it includes not only the interest rate. but also some closing costs, fees paid to brokers, and points paid to reduce your mortgage interest rate.
APR does not apply just to mortgage loans; consumers may also receive an APR when they apply for a credit card.
Annual percentage rate example
When shopping for a mortgage, it is important to understand that APR is an annualized interest rate that is calculated by taking the base interest rate and adding points, fees and closing costs to the total.
For example, say you have a $320,000 mortgage with a 30-year fixed-rate of 5.5 percent. The following fees may be added to the loan:
- Origination fee: 1 percent ($3,200)
- Loan points: 1.5 percent ($4,800)
- Other closing costs: $800
Your total additional costs are $8,800, making your loan annual percentage rate 5.747 percent.
When quotes are received from multiple lenders, it is important to determine which fees are included in the APR calculation. For example, some lenders may exclude private mortgage insurance (PMI), or other costs. It is always a good idea to review the good faith estimate provided by the lender to determine which fees have been included in the APR.
If you are considering refinancing an existing mortgage, or buying a new home, it s important to determine the annual percentage rate so that you can see what the loan is really costing you on an annual basis.