Annual Percentage Rate

What is it?

The annual percentage rate or APR is required by the Federal Truth in Lending Law in an effort to present borrowers with an accurate depiction of the cost of a loan. It is designed to aid consumers in their selection of a loan when comparing the various types and terms that are offered by lenders.

In essence, the annual percentage rate should reflect the actual cost of obtaining a loan on an annual or yearly basis. It expresses the relationship between the amount of money that is borrowed and the cost of obtaining this sum of money as a loan. The APR includes many of the fees associated with the loan.

Most financial lenders have their own formulas for calculating the APR or annual percentage rate. Therefore, while the comparison of loans has been made easier, it is still not perfect. Some companies use a software program to determine the APRs of the loans that they offer. Perhaps their agents do not even know what fees are included in the calculation of the APR.

In general, if one APR is higher than another, the loan is going to cost the consumer more money on an annual basis. For example, a mortgage lender might offer a 30-year fixed rate loan with an interest rate of 7.5%. A different mortgage lender might offer a 30-year fixed-rate loan with an interest rate of 6 %. On first glance, the second loan looks like it is the better choice.

However, let’s say that the second mortgage lender is also charging points or a percentage of the loan amount for the privilege of acquiring the lower interest rate. Typically, this equates to an additional cost. Since points are reflected in the annual percentage rate or APR, the APR will be slightly higher for the second loan than the APR for the first loan. This should tip off the borrower that extra fees are included with the second loan and it actually might not be the best option after all.

by
Susan Keenan

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