Home buyers who have begun looking into obtaining a mortgage often wonder about the difference between interest rate and APR . Simply, think of the interest rate as the starting point in what you will pay for a mortgage loan, then tack on associated fees to calculate the APR.
To understand these concepts, below we will start with definitions:
What is the interest rate?
The interest rate is the percentage of the loan amount that is charged for the money you are borrowing. This can be considered a base fee. It is very important when comparing different loan quotes because it directly affects monthly payments.
What is the Annual Percentage Rate (APR)?
The APR is a calculated rate that not only includes the interest rate but also takes into account the other fees from the lender which are required to finance the loan. The point of APR is to help consumers understand the tradeoffs between interest rate and the fees paid at the closing. The government thought this was important so they required it to be shown next to the interest rate as part of the Truth in Lending Act.
How APR is calculated?
To calculate the APR, the lender fees are integrated into the interest rate. This is done by amortizing the fees out over the life of the loan as if they were additional payments, and then calculating a new interest rate.
The fees are added to the original loan amount ($300,000 + $3,000) to create a new loan amount ($303,000). This new loan amount, along with the interest rate,is used to calculate a new monthly payment. The APR is then calculated by working backwards to figure out what the rate would have to be for a loan with the new monthly payment and the original loan amount. The APR is generally higher than the interest rate because it includes the fees.
As useful as the APR can seem, it does have its limitations. APR spreads the fees paid upfront over the life of the loan. So the comparison of APR is only accurate if you plan to keep the mortgage for the entire duration of the loan. Since most borrowers do not keep their loan for the full period, the APR can make some loans look artificially better.
The other problem with APR calculations is that different lenders may include different fees in their APR calculations for various loan programs. Remember to always ask your lender what is included and not included in your APR. We can recommend some of the best lenders to work with in Boca Raton. Please feel free to give me a call at 561-843-7010.