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What is APR?

By Arvin Sahakian · Nov 8, 2014 · Mortgage

What is APR?

Image courtesy of LendingMemo, LendingMemo

Learn what APR is, how to quickly calculate it and what it means to you when choosing a lender and mortgage loan.

For millions of people across the country the purchase of real estate (and the mortgage) is likely to be the single most important financial decision an individual or family will make during their lifetime. There is no lack of horror stories, and there is no lack of success stories either, so the genuine concern you have for making a successful decision is completely valid and understandable.

Definition of APR (Annual Percentage Rate)

APR is the annual rate you are charged for borrowing a mortgage loan, expressed as a single percentage number that represents the actual yearly cost of borrowing over the term of your loan. APR includes the interest rate you pay, and the closing costs you are charged to attain your loan.

APR = Interest Rate + Closing Costs

APR is a useful reference to gain a broad snapshot of the true cost of your loan. Fortunately, estimating APR is not too difficult.

Let me share with you a quick method to calculate your APR for a 15, 20, 30 or 40 year fixed loan, without the use of the internet, armed only with a simple everyday calculator. Feel free to use this to impress your friends at the next cocktail party!

Quick "Cheat Method" to Calculate Your APR

Step Example
1. Determine your closing costs:
     a) Lender origination fee
     b) Other closing costs

2. Determine the number of months you'll be paying your loan: 30 years
x 12 months
360 months
3. Divide your total closing costs by the number of months: $7,000 ÷ 360 =
4. Divide the result above by 100: 19.44 ÷ 100 =
5. Determine your interest rate: 4.00%
6. Add the result in step 4 to your interest rate: 4.0000%
+ 0.1944%
7. Bingo! This is your estimated APR: 4.1944%

APR is the True Cost of Your Loan

When getting a mortgage you'll be quoted an interest rate, which is the cost to borrower money. For example, a $300,000 loan multiplied by a 4% rate costs you $12,000 of interest in your first year and slowly decreases in subsequent years as you can see in this loan amortization schedule.

But wait, there are additional fees you are charged to attain your loan. In the "Cheat Method" above you'll notice $4,000 in origination fees and $3,000 in closing costs. When you combine these total closing costs with the interest rate charge, you come up with an APR which is the true annual cost of your loan.

Note: the above cheat method only estimates your APR reasonably for fixed loans between 15 and 40 years. Accurately determining your APR actually requires some really complex math. Use this APR Calculator to easily determine what your APR is without having to rely on the lender to disclose it.

  1. Type in your Loan Amount
  2. Type in your Loan Term in months (30 year fixed loan x 12 months = 360)
  3. Type in your quoted Interest Rate (this is the rate your monthly payments are based on)
  4. Type in your Finance Charges (total fees charged by your lender)
  5. The APR calculator will automatically calculate your APR.

BeSmartee TipTip: The federal Truth In Lending Act (TILA), requires that your lender disclose important terms of credit for the real estate mortgage you applied for, such as the APR. Additionally, TILA will include your finance charges, monthly payment and whether or not you can repay your loan early without a penalty.

APR Should Not Be Your End-All Tool in Decision Making

Getting caught up in the whole Mortgage APR thing can seem a bit overwhelming to say the least.

APR is a useful tool when shopping which lenders to use. Keep in mind that the fees lenders use to calculate your APR can vary, which means the APR can vary. Therefore, the APR is an important number, but should not be the only number you rely on.

Just remember that your monthly mortgage payments are based on the interest rate quoted and not the APR. To get a complete picture, make sure to review your Good Faith Estimate (GFE) which will show you the interest rate AND an estimate of all closing costs required to close your loan.

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