If you’re interested in purchasing your first home, then you should be prepared for a lot of unfamiliar lingo. Especially if you’re going to finance your home. One phrase you’ll see repeatedly is “annual percentage rate” or APR.
An APR is the annual cost of funds for the duration of your loan. This includes your interest rate, and any additional costs that have been rolled into your monthly payments, such as origination fees or closing costs. Because rates and fees can vary by lender, APRs provide borrowers with a value that’s easy to compare against each other.
In short, the APR is the amount your will pay per year in exchange for borrowing money.
Calculating Your APR
Though you probably won’t ever have to use it yourself, there is a simple formula for calculating and APR:
Breaking Down Your APR
You’ll typically see the APR expressed as a percentage. This percentage reflects the portion of the principal is to be paid per year, again, including monthly payments, and fees.
It is important to be aware that APRs don’t account for compounding interest within a given year.
APRs for home loans can be issued as a fixed rate, or an adjustable rate. Fixed rate APRs have an interest rate that will remain constant throughout the duration of the mortgage, while an adjustable will have an interest rate that fluctuates with the market. This makes it difficult to predict the accuracy of an APR for an adjustable rate mortgage (ARM), as rates tend to be lower with the risk of them increasing.
Nominal Interest Rate
The nominal interest rate is your interest rate without any additional fees or costs included. Therefore, the APR tends to be a larger value than the nominal interest rate. For example, if two lenders are offering the same nominal interest rate, but with different APRs, then the lender with the lower APR would be offering the better deal, as there are less fees associated with the loan.
Some feel that APRs do not accurately depict the total cost of borrowing, as there are other fees that need to be paid that are not directly related to the loan itself. These could be fees for inspections, appraisals, and credit reports. These fees are necessary for obtaining a home and a mortgage, but they are likely not included in the APR.