New home shoppers, when they have begun to search of best mortgages, often may get confused between the two terms namely Annual Percentage Rate and Interest rate. The interest rate is considered as the beginning point in what one will pay as interest for the mortgage loan amount, and then come the associated fees that get tacked on in order to ascertain the APR.
What exactly interest rate mean?
It is a certain percentage of the borrowed loan amount being charged which may be considered as the base fee. It is very significant that you must compare different loan quotes before sticking on a choice as it will directly create an impact on your monthly payments.
What exactly APR mean?
APR means Annual Percentage Rate which is ascertained, including the interest rate, still also considers other lender fees needed to finance the loan. The concept behind APR is to assist the consumers to know the trade-offs between the fees paid during closing and interest rate. According to the Government it was vital so they needed to show this subsequently to the interest rate as a section of the Truth in Lending Act.
Conceptually, in order to calculate the APR, fees needed to finance the loan namely the lender fees are included in the interest rate. This is performed by amortizing the fees out on above the tenure of the loan as if such charges were additional payments and ascertaining a new rate. Generally, the APR will be higher than that of the interest rate as it includes the fees.
Backlogs with APR
Similar to the benefit with APR, there are certain limitations also exists with it. Under the APR method of calculation, the fees paid upfront will be spread over the entire tenure of the loan. So, the comparison of APR can be correct only if one plan to withhold the mortgage loan for the entire tenure of the loan. But, in most cases, borrowers will not show interest to keep their loan for the entire life of the loan as they typically switch over to refinance or move.
Hence, the APR can create few loans to look artificially better than others. For an instance, if one keeps a loan only for 3 years of span and planning to get second loan, then it will cost much costlier in spite it has a lower APR.
Also, the other issue with the calculation of APR is the distinct lenders may include distinct fees in their calculation of APR for different loan programs. It is always recommended that one who is planning to get a mortgage loan for purchasing a home must ask their lender regarding what are all included and not included while calculating the APR.