Annual Percentage Rate (APR)
Annual Percentage
Rate Calculator
What you need to know about the Annual
Percentage Rate (APR)?
The APR is used to calculate what the total cost of the loan would be
as a yearly interest rate over the life of the loan (with all fees
included). But, the best use for borrowers is to calculate which
loan is cheaper over the time period you are most likely to keep it.
Let's say you're quoted an interest rate of 6.0% on a 30 year fixed
loan from three loan officers with APR's of 6.57% - 6.45% - 6.65%, from
this information you can determine that the second choice will be
cheaper over the 30 year term of the loan. Provided all
calculations were done correctly.
Fees which are
generally included when calculating the APR are:
- Origination fees/points
- Discount fees/points
- Pre-Paid interest: Interest paid from the date the loan closes
to the end of the month.
- PMI(Private Mortgage Insurance)
- Processing fees
- Closing agent/Title company fees
- Application fees
- Document-preparation fee
Remember to keep in mind there are many mortgage professionals who do
not calculate the APR correctly. Most loan officers use a software
program designed to calculate it for them and if the incorrect
information is imputed by mistake, or otherwise, it will most likely not
be caught until the closing agent/title company reviews the documents.
When borrowers discover the higher cost many will go ahead and pay the
higher fees, fearing they may not get another loan in time. The
best way to avoid this situation is to understand the fees being charged
and not to use the APR calculated by loan officers as the only way to
look at the cost of the loan.
Looking at how long you plan on keeping the loan is as important as the
interest you will pay. Today most people now only keep a mortgage
loan 5-7 years on average, so make sure the loan officer runs different
loans and costs for your particular situation. If they tell you
this can't be done then move on to another loan officer, because this
one is either too inexperienced to know or just dishonest.
Example of a $300K, 30 year fixed loan kept for the national
average of just 5-7 years-
- A $300k loan with an interest rate of 6.0% and a APR of 6.255%($6000
in total fees) would indeed cost you only 6.255% if kept for the full 30
years, but would suddenly change into an APR of 6.844% if kept for only
5 years. Not the best way to go. Although, initially it looks very
tempting you're still paying the same fees, just over a 5 year period
instead of 30 years. Even if you kept the loan for 7 years it would
still carry an APR of 6.619%
- A $300k loan with an interest rate of 6.50% and an APR 6.517%($500
in total fees) would indeed cost you 6.517% if kept for the full 30
years, but changes to 6.57% if kept for just 5 years. This loan would
cost you 6.57% per year for the 5 years you kept the loan, obviously the
best way to for the average borrower who only keeps a loan for 5-7
years. This loan would still be the better choice after 7 years with an
APR of 6.552%
Most borrowers even if they know they will only be in the house for 5
years have a hard time comprehending a loan which has a higher interest
rate will actually cost them less. But as stated above, if you
have your loan officer run the APR for the time you plan to be in the
house you are always better off.
Even if something unforeseen happens and you're in the house for a
few more years then you originally thought. The difference between
the loans will be negligible on fixed rate loan products.
I'm sure some of you are wondering how it's possible to have $500 in
fees versus $6000. The loan officer uses a payment (yield
spread premium) he receives from the lender to pay for most of your
fees (title, appraisal etc.) and keeps the remainder as profit;
turning loan choice #2 into a true low (almost no) cost mortgage loan.
(Disclaimer - Loan choice number one has fees set to 2% or $6000 of
the loan which would actually be low considering many people can pay
anywhere from 2.5% - 3.0% ($7500 - $9000) or more in fees for the
average loan. This would bump up the APR even further on loan
number one making it even less desirable. We wanted to show you
that even with low fees of 2% on loan number one, loan number two was
still much cheaper over the 5-7 year time frame.)