Annual Percentage Rate
hile APR is not necessarily the best indicator of the total cost of a loan, it is the best way to compare mortgages.
APR shows the total cost of a mortgage
Lenders break up the amount that they charge you into interest rate, fees, and points. By looking at either only the fees and points or only the interest rate, you don't see the whole picture. Using APR helps you compare apples to apples.
An APR combines the two, so that you won't be confused by different fee and interest rate combinations.
APR is universal
Lenders and brokers are required by law to provide you with an APR when they quote you the rate of a loan. So, if you are looking at loans from two different lenders, or from a broker and a lender, you can compare the loans' APRs to see how the loans' total costs differ.
Example: $100,000 fixed rate mortgage
You're looking for a 30 year fixed rate loan and have quotes from two lenders. The first lender quotes you a 7.875% interest rate with $2,000 in fees (including discount points). The second offers you an 8% interest rate with no fees or points.
Rather than doing the math to figure out which of these two lenders' loans is cheaper, you could just look at the APRs and see what the total costs are.
Although APRs are the best way to compare mortgages from different lenders, they still have two major drawbacks: Ask your broker or lender exactly which costs are included in the APR calculation.
Different fees in calculation
Although lenders are required to show the APR, they don't all use the same fees in the calculation. You have to be careful to make sure the two APRs that you are comparing use the same fees to do a true apples-to-apples comparison. Otherwise you could end up comparing a golden delicious to a crabapple.
Not your true cost
An APR calculates the total cost over the full term of a mortgage, but few people keep a mortgage for that long.
A typical mortgage might have a 30 year term, but few people hold them for more than 5 years.
This means that the APR calculation includes interest that you will never pay and spreads the closing costs over too many years.
How APR is calculated
To calculate APR you need to use an IRR (internal rate of return) function. The function uses your loan amount, lender and broker fees and points.