A home loan involves a lot more than paying principal and interest. There are numerous fees involved in home loans, from loan origination fees, to points and funding fees, depending on the type of loan. Some loans even require the borrower to pay a continual cost for impound accounts. The annual percentage rate, or APR, is a tool that helps the borrower to identify the true costs of obtaining credit.
Annual Percentage Rate
Annual percentage rate is a number that shows how much money it will cost you, in a yearly percentage, just for the privilege of having a mortgage. Lending Tree states that the formula for APR combines the cost of the interest rate with all of the other fees involved in the loan and divides them by the number of years in the repayment term to calculate the percentage.
Various Fees
The many fees involved in calculating APR include discount points, which are sometimes paid upfront to buy down an interest rate, and loan origination fees, which the lender charges as a way to make profit off of the loan. The financial website AllBusiness.com states that mortgage insurance premiums and prepaid mortgage interest are also included in the APR.
Fixed or Variable Interest Rate
Lending Tree states that APR shows the full costs of obtaining credit on both fixed or variable interest rate loans. They state that APR is generally more useful when used to compare fixed-rate mortgages versus for adjustable rate mortgages since the APR for adjustable rate mortgage is merely an estimate based on possible changes in interest payment amounts.
Comparing APRs
Comparing annual percentage rates is an excellent way to compare different mortgages. AllBusiness.com states that though one bank may offer a lower interest rate for the same repayment period as another, the APR may show that the loan with the slightly higher interest rate may be in fact the better choice if loan origination fees, points and other fees are lower.
Truth in Lending Act
The Truth in Lending Act requires APR to be displayed by lenders on any loan advertisement. Lending Tree states that the APR is usually next to the note rate on advertisements made by lenders. The purpose of the Truth in Lending Act was to prevent lenders from hiding certain fees and thereby taking advantage of consumers.
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