Annual percentage rate (APR)
What is annual percentage rate (APR)?
Annual percentage rate, or APR, is a way of measuring the full cost a lender charges per year for funds. Typically associated with mortgages, loans and credit cards, APR combines the total amount of interest payable and the cost of other fees and charges, averaged over the term of the loan and expressed as a percentage.
Lenders typically quote two rates for their products: interest rate and APR. The interest rate represents the interest charged on the loan. However, there are other costs and fees associated with taking out a loan that are added to the cost of interest to arrive at APR. Note that both APRs and interest rates can be variable or fixed, depending on whether they are tied to changes in benchmark rates or not.
Depending on the type of loan, the other costs rolled into APR may include origination fees, closing costs, broker fees, or mortgage points. A frequently added cost is private mortgage insurance, which protects the lender from a default. APRs are by definition higher than interest rates. The additional costs factored into APR can be added to the principle and averaged over the term of the loan (and accrue interest over the loan’s term), or treated as a short-term loan due early in the loan’s term, typically the first month’s payment.
The APRs quoted for loans, mortgages and credit cards generally are calculated on the basis of simple interest, without taking compounding into account. A related concept is annual percentage yield, or APY, which represents the rate of profit you get from depositing funds in a certificate of deposit, savings account or money market account.
Use this handy annual percentage rate calculator to determine what your mortgage APR is.
Annual percentage rate example
When shopping for a mortgage, the borrower should understand that APR is an annualized interest rate that is calculated by taking the base interest rate and adding points, fees and closing costs to the total.
For example, Lina has a $320,000 mortgage with a 30-year fixed rate of 5.5 percent. The following fees are part the loan:
- Origination fee: 1 percent ($3,200)
- Loan points: 1.5 percent ($4,800)
- Other closing costs: $800
Lina’s total additional costs are $8,800, making her loan annual percentage rate 5.747 percent.