Tip of the Month - April 2006

What is the Annual Percentage Rate (APR)?

The true cost of financing is not easy for consumers to determine. One of the difficulties of shopping for a loan is that financing costs include more than just the interest over the term of the loan. The Annual Percentage Rate or APR was designed to make it easier to compare loans by providing a single comprehensive measure of the true cost of credit over the life of the loan. Lenders are required by law to report this rate under the Truth-in-Lending regulations.

The Annual Percentage Rate is calculated by taking into account the interest rate (the actual note rate), the "points" which are based on a percentage of the loan amount, and other cash charges such as credit report fees which are a fixed dollar amount regardless of the size of the loan. The APR is also adjusted for the time value of money, so that money paid by the borrower up front carries a heavier weight than dollars paid ten years into the term of the loan. The problem with this formula is that most borrowers pay off their loans before the end of the loan term by refinancing or selling the property. This makes the APR calculation somewhat deceptive for borrowers with shorter timelines.

As a general guideline, if you believe you will be in your home for at least ten years, the APR may be a more useful tool to use in comparing loan costs. Otherwise, you might want to focus on the interest rate and the upfront cash fees you will be required to pay at that rate. With the fixed rate loan, the best deal is probably the one carrying the lowest total fees, but other terms of the loan can also be important factors in your decision. Your mortgage broker or real estate agent is qualified to assist you in finding the financing package which will work best for you. Consult your real estate professional for advice about your specific needs.

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