What is APR (Annual Percentage Rate)?

APR (Annual Percentage Rate is the true cost of a mortgage loan and there are two kinds of annual percentage rates: the nominal APR and the effective APR. The one you should be concerned with is the effective APR.

Nominal Annual Percentage Rate (Nominal APR)

The nominal APR is the simple interest rate for the mortgage loan for one year. The effective APR is the compound interest rate and any fees that were rolled into the loan (if any), it’s the total interest paid divided by the amount of money received. In other words, it’s the effective APR you should concern yourself with.

The mathematical formula for finding the Annual Percentage Rate is complex. The easiest way to calculate it is to use an online home mortgage calculator.

Effective Annual Percentage Rate (Effective APR)

The effective Annual Percentage Rate is problematic. On 4 levels:

1. No one knows exactly what the exact fees involved in your mortgage are going to be until late into the mortgage process, sometimes till closing. When mortgage brokers or loan officers quote you an Annual Percentage Rate, they may or may not be honest. Even if they are honest, they’re basing it on what’s been typical for them. What if your loan is not what’s typical for them?

2. That is not the only thing that can be different. By the time of closing, they might have to change lenders and/or programs. These changes can drastically change the total amount you are going to pay in fees, therefore, the total amount that can be included in the mortgage (payments).

3. In addition, the APR quotes you get online are based on sample loan amounts. If your loan amount is not exactly the same, your APR is going to be different.

4. Since there are so many fees that may but don’t have to be included in the APR, it is easy to manipulate APR’s. And there are mortgage brokers and loan officers who do it. They lower intentionally the APR. To safeguard against being taken in in this manner, ask for a list of all their fees, rates, and points. Also get a written guarantee.

Annual Percentage Rate (APR) Caveats

Generally speaking, APR quotes that are one quarter of a percent lower than the other quotes you’re getting should raise red flags. The odds that they’re not true are really high. Or else they are not basing their rates, fees, or programs on Fannie Mae or Freddie Mac.

Final caveat, APR’s are a function of the loan amount and the term. When comparing mortgage loans, do not use the Annual Percentage Rate unless you’re looking at the same loan amount and the same terms.

So, a mortgage loan with a quoted Annual Percentage Rate of 6.2% might be, in real life, less expensive than one with a quoted Annual Percentage Rate of 6.5% (because it included fees you’ll have to pay that the first one did not).

In other words, Proceed with caution: Annual Percentage Rate (APR) is always on the prowl!