When applying for loans, aside from interest, it is not uncommon for lenders to charge additional fees or points. The real APR, or annual percentage rate, considers these costs as well as the interest rate of a loan. The following two calculators help reveal the true costs of loans through real APR.
General APR Calculator
Real APR: 6.335%
|Upfront Out-of-Pocket Fees||$1,500.00|
|Payment Every Month||$1,110.21|
|Total of 120 Payments||$133,224.60|
|All Payments and Fees||$134,724.60|
Mortgage APR Calculator
Use the calculator below for mortgage loan in the United States.
Real APR: 4.608%
|Total of 360 Payments||$364,813.42|
|All Payments and Fees||$366,313.42|
The real APR is not the same thing as interest rate, which is a barebone number that represents the cost of borrowing on the principal amount. While useful, interest rates do not offer the accuracy a borrower really wants to know in determining which rate from which lender is the best deal. Real APR does this by factoring into the interest rate any other additional costs associated with the loan. For most loans, lenders have wiggle room for what they decide to include in the APR.
Quick Tip 1: Lower APRs are generally better for any borrower because they result in less interest payments with all else being equal. However, when it comes to complex things like mortgages, there are so many other factors to consider, and it is important for borrowers to understand and evaluate all these factors together.
While allocating the fees, it is presumed that the loan runs its course . For any borrower who plans to pay their loan off much quicker, APR will tend to underestimate the impact of the upfront costs. All these costs look much cheaper spread out over a 30-year mortgage rather than a rapidly accelerated repayment in 10 years.
APRs are the conventional measurement of loan costs, not interest rates. In the US, lenders are required by law as a mandated disclosure under Truth in Lending Act to display APRs so borrowers can easily compare between competitors. Though sometimes, lenders may offer 'no-fee' loans. For these, if the rate is fixed, the interest rate and APR should be the same.
The following is a list of common fees that are normally packaged into mortgage APRs. Of course, every lender is different, and these are just rough generalizations. It is best to ask lenders to list out all fees packaged into individual APRs to be entirely sure.
Fees usually exempt from APR are:
- Appraisal fee
- Builder Warranty
- Pre-paid items on escrow balances, such as taxes or insurance
- Intangible tax
- Title inspection
APRs can be fixed or variable, and there are pros and cons to each.
Loans with fixed APRs contain rates that are guaranteed not to change during the life of the loan. It would be wise for a borrower who received an extremely enticing fixed rate to lock it in during a period of relatively low market interest rates that are scheduled to rise later. Fixed rates are generally higher than variable rates at the time of loan origination.
Loans with variable APRs have rates that may change at any time, usually due to its correlation to an index. For instance, if market interest rates go up, most of the time, variable APRs tied to loans will go up. There is another component to variable APRs called a credit-based margin, created by the lender. This is just a fancy word for the portion of an extended variable APR offer to a potential borrower not determined by the market index, but the creditworthiness of the borrower. Including the credit-based margin for evaluating variable rates for each individual disallows borrowers with creditworthiness scores in shambles to take advantage of a system kindly offering flexibility. As an example, variable rates are probably better for someone who took out a loan during relatively high market rates that are forecasted to decline . It is important to note that studies with historical data have shown that borrowers generally paid less interest going with a variable rate as opposed to fixed.
Whichever the case, it is more important to consider the duration of the loan. Generally, the longer the loan, such as a thirty-year mortgage, the greater the impact of fluctuations in a rate.
APR vs. APY
It may be helpful for potential borrowers to make the distinction between APR and APY, which is annual percentage yield, a term that is mostly associated with deposit accounts. APY is a rate that reflects the total amount of interest paid on an account, based on a given interest rate and the frequency of compounding in a 365-day period. APY can sometimes be called EAPR, effective annual percentage rate, or EAR, effective annual rate. The main difference between these and APR is that the former considers compounded interest while APR doesn't. Because financial institutions want to advertise the most enticing rates possible to their clientele, borrowers are given APR rates instead of APY because the rates are smaller, whereas owners of savings accounts will be advertised APY rates because they are higher due to the compounding interest involved. For example, if a $100 CD has an APY of 10%, the interest received at yearend is:
$100 × 10% = $10
$10 in interest is received. Comparatively, if a loan of $100 is borrowed at an APR of 10%, the equivalent interest paid at yearend can be computed. If looking for only the rate of effective APR, use the following formula:
|)n - 1|
|)12 - 1 = 10.47%|
To find the actual amount of interest paid, use this formula instead:
|Principal × ((1 +||
|)n - 1)|
|$100 × ((1 +||
|)12 - 1) = $10.47|
$10.47 in interest will be paid.