What is annual percentage rate (APR)?
The annual percentage rate, or APR, is the actual cost a borrower pays to the lender on a debt after adding together interest and other fees associated with the loan. When a borrower receives a quote on a mortgage or credit card, she may receive both the standard interest rate and the APR. Both will be expressed as a percentage of the principal, with the APR always higher because it includes the interest rate as well as additional costs.
When a mortgage lender provides a quote to a customer, it will indicate an interest rate, either variable or fixed, quoted as a percentage of the principal, which reflects the cost the borrower pays for the privilege of borrowing from the lender.
APR is also quoted as a percentage; however, it includes not only the interest rate, but also some closing costs, fees paid to brokers, and points paid to reduce the mortgage interest rate. Such fees could differ widely from lender to lender. While it seems like a lot of additional costs on top of the interest, in reality the APR often isn’t more than a few percentage points higher than the initial interest rate.
Rather than distinguish between interest and APR, some banks simply refer to two types of APR: corresponding, or nominal, APR, which is the basic interest rate, and effective APR, which is the total including all additional charges.
Some common fees included in the APR are:
- Prepaid interest, including mortgage points, which a borrower can opt to pay to reduce her interest rate.
- Private mortgage insurance, for when the borrower defaults and the lender needs to recoup its losses.
- Legal fees associated with the closing of the mortgage.
- Handling fees, such as the origination fee assessed on the opening of a new account.
However, some of these fees may be included as separate costs rather than factored into the APR. These fees will be indicated to the borrower up front.
Use Bankrate’s mortgage APR calculator to determine what your APR is.
Annual percentage rate example
Luke has a $320,000 mortgage with a 30-year fixed rate of 5.5 percent. The following fees are added to the loan:
- Origination fee: 1 percent ($3,200)
- Loan points: 1.5 percent ($4,800)
- Other closing costs: $800
His total additional costs are $8,800, making his APR 5.747 percent.