Mortgage Basics #Home Buying

What is APR? | APR vs Interest Rate

What is APR? | APR vs Interest Rate


When you are taking out a loan, the lender lets you know ahead of time the base interest rate, which is of course, an essential disclosure. The interest rate is only the percentage that the lender charges for lending money, and is not concerned with other fees involved in the process. 

As a result, you might be prepared to cover the monthly costs of base interest payment, without adequately preparing to cover the costs of other charges and fees. This is where apr comes in, it is known as the parameter that reflects the true cost of borrowing. So, what is apr or what does apr mean?

Key Takeaways

  • What is an annual percentage rate? APR or annual percentage rate simply sums up your interest rate alongside other fees and charges 
  • APR gives you a clearer image of the costs that you would be incurring when you take out a loan, so you can account for apr finance
  • Calculating APR is simple and straightforward and can either be done manually or using an APR calculator 

What is APR (Annual Percentage Rate)?

What does APR mean? Annual Percentage Rate (APR) serves as a broader form of disclosure or offers full disclosure of all the costs involved in borrowing money compared to the interest rate. 

It usually details mortgage broker fees, points, as well as other charges that you are required to pay in order to access a loan. For instance, if payment of origination fee or points is a requirement, this expense would be noted in the APR. As a result, the APR comes around to being higher than the interest rate.   

Basically, the APR indicates the total interest amount that you would be required to pay annually (averaged over the loan’s full term) on your total mortgage loan amount. In other words, it is regarded as an annual rate and allows to compare among lenders, credit cards, or investment products. 

A higher apr interest rate implies a higher  monthly interest rate higher amount of monthly mortgage payments, and vice versa. APRs are usually included alongside regular interest rates when mortgage rates are being outlined. This covers what’s APR.

APR vs Interest Rate: Key Differences

Considering the key differences when evaluating APR vs interest rate requires highlighting what each parameter represents. Interest rate, which is usually expressed in percentage, serves to reflect the present cost required to borrow money. 

It does not consider other fees or charges involved without which you would be unable to access said loan. The APR on the other hand presents a clearer and more profound view into the entire cost implication. This is necessary to define apr. 

APR usually highlights the interest rate and then includes other lender fees and charges necessary for the loan to be financed. This is why apr rate is vital and mandatory. 

Do You Pay Both APR and Interest Rate?

Simply answering in the affirmative here may result in confusion, hence the need for a breakdown. What is APRinterest? The APR comprises the interest rate, alongside other fees. The reason that the APR is important is the fact that it does include these other fees which are not reflected in the interest rate. 

In other words, if you pay your APR, then you have covered your interest rate as well. On the flip side, paying just the base interest still leaves some unpaid fees and charges that the APR highlights.

So, do you pay both APR and interest rate? Not necessarily. However, you definitely pay the interest rate + other fees = APR. The APR is usually higher than the interest rate. 

How to Calculate APR

To calculate mortgage APR, you would need to determine the following criteria first:

  • Periodic interest rate on loan (monthly or semi-annually rate)
  • Total sum of loan principal 
  • Number of days in repayment term
  • Amount made as monthly loan payments 
  • Interest and fees charged over the life of the loan
  • Discounts applicable 

The basic formula is: ((Fees + Interest) ÷ (Principal) ÷ (# of Days in Term) x 365) x 100

Using a basic example, take for instance that your loan amount is $2,000. It has a 300-day loan term, and interest is pegged at $165 with origination fee of $35 required to take out the loan. 

To calculate APR here:

First, add the origination fee and total interest paid.

$165 + $35 = $200

Then, take that number and divide it by the loan amount.

$200 / $2,000 = 0.1

Next, divide the result by the term of the loan.

0.1 / 300 = 0.00033333

Then, multiply that result by 365.

0.00033333 x 365 = 0.1216666667

Finally, multiply that by 100 to get the APR.

0.1216666667 x 100 = 12.17%

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Calculating APR on a Simple Interest Loan

To show how APR is calculated on a simple interest loan, here is an example: say you took out a loan of $200 for 30 days. Interest charged is $4, and fee paid is $1. At the end of the 30 days, you pay up the entire loan. APR meaning finance would be calculated like this: 

Following the method highlighted in the example above:

First, add the origination fee and total interest paid.

$4 + $1 = $5

Then, take that number and divide it by the loan amount.

$5 / $200 = 0.025

Next, divide the result by the term of the loan.

0.025 / 30 = 0.00083333

Then, multiply that result by 365.

0.00083333 x 365 = 0.304166666667

Finally, multiply that by 100 to get the APR.

0.304166666667 x 100 = 30.41%

The APR here is therefore 30.41%. 

This calculation helps you understand what APR financing is. 

Calculating Amortizing APR on a Mortgage

Amortized loans refer to those that are not paid off at once, rather, they require making regular, scheduled payments periodically. The payments you make comprise a sum that goes to paying off the principal while the other serves as interest. As principal reduces, interest payments also gradually reduce, thereby increasing the portion of the payment that is used to pay off principal. 

Calculating APR for an amortized loan does not involve using the exact amount you borrowed. Rather, the average principal balance outstanding for the entire life of the loan is used. You can derive this by simply splitting your actual loan amount into two. 

In the early stages of mortgage repayments, the interest portion is usually larger and then reduces towards the end, making the principal portion increase. At the end of the day, this would make your actual average less than half. 

Before manually calculating your APR, an amortization calculator can first be used to calculate actual average principal outstanding.

Common Mortgage Fees Not Included in APR

Common mortgage fees not included in APR include:

  • Title insurance 
  • Home inspection fees (if lending bank does not require inspection)
  • Mortgage prepayment penalties
  • Mortgage default insurance 
  • Legal fees for services (services lending bank does not require)

When defining what is the annual interest rate, these fees are not included. 

Final Thoughts

Beyond comparing interest rates, if it is an APR loan, it is important to compare APR before opting for a particular lender. You should look out for a lower APR which would imply lower monthly mortgage payments. Similarly, you can either manually calculate your APR or use an APR calculator. 

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