APR – “A”- Annual Percentage Rate

In this post I’ll teach you how to shop using the APR as one of the parameters. Remember, this number is one of many factors you need to consider when shopping for a mortgage because I want you to focus on getting the best overall deal.

Definition

Consumer Financial Protection Bureau’s definition is:

“An annual percentage rate is a broader measure of the cost to you of borrowing money, also expressed as a percentage rate. In general, the APR reflects not only the interest rate but also any points, mortgage broker fees, and other charges that you pay to get the loan. For that reason, your APR is usually higher than your interest rate.”

The annual percentage rate is a number representing what the interest rate of the loan would be if the loan had no closing costs. For example, a loan with an interest rate of 5.25% that has $0 in closing costs will have an APR of 5.25%.

Buy this calculator on Amazon to calculate the APR.
I use the Qualifier Plus IIIFX calculator to calculate the annual percentage rate.

The APR that you see presented to you in loan estimates is calculated by a computer. Loan Processors, working for lenders, input information about the loan, most importantly–total costs, into a LOS (Loan Origination Software). The LOS then generates APR disclosures.

Reliability

The annual percentage rate itself is not a reliable basis of comparison for mortgages and you can’t rely solely on this number for many reasons. The top three reasons are:

  1. A lower APR loan might not be the best fit for you,
  2. A lower APR loan might have a higher monthly payment,
  3. Loan Processors make mistakes; the disclosed number may be inaccurate.*

There are other very important things to consider, that we’ll cover using the ATOMIC method, so make sure to read the entire blog.

Method

Are we still going to be using the annual percentage rate for loan shopping? Yes, we are, because it is still a useful indicator in our analysis.

We want a low APR.

A lower APR means lower total costs of the loan–including the interest you pay to the lender and their fees. Therefore, the lower the number, the better. If you’re comparing two identical loans side by side, take the one with the lower number because it will save you money.

In general:

  • the lower the rate is, the lower the APR;
  • the shorter the repayment period, the lower the APR;
  • the lower the costs of the loan, the lower the APR.

Conclusion

You’re now one step closer to being one of the most educated mortgage shoppers in your neighborhood. Remember, this number is one of many factors you need to consider when shopping for a mortgage. It is by no means the only thing to consider. Read my next blog post, about the “Time” factor, to improve your mortgage shopping skills.

Resources

If you’re interested in learning more about what is included in the APR, here are some resources:

Applicable law: 12 CFR §1026.22

Truth In Lending Act Definition

CFPB Definition

 

* To quickly touch on point #3: The annual percentage rate calculation done by the LOS is based entirely on the input from the Loan Processor. Human error does cause big differences in these numbers, and there could be lenders that purposely understate closing costs to make their offer look better. If you don’t believe that lenders can do things like that, just look up the numerous cases of lenders being fined by the government for not following laws, guidelines, and procedures; you will find plenty of examples of, sometimes negligent, misconduct within the lending industry. Besides, software errors can cause problems too.