What is APR and Why Does It Matter?
The Annual Percentage Rate (APR) represents the total yearly cost of a loan to a borrower. Unlike a simple interest rate, the APR includes other charges or fees (such as points, mortgage insurance, and origination fees) expressed as a percentage.
How APR is Calculated
To calculate the APR, we determine the monthly payment based on the total loan amount, then find the interest rate that would result in that same payment if the loan amount were reduced by the total fees.
$$APR = \left[ \left( \frac{\text{Total Interest} + \text{Fees}}{\text{Principal}} \right) / \text{Days in Loan Term} \right] \times 365 \times 100$$
Interest Rate vs. APR
A loan might advertise a 6.0% interest rate, but after adding $5,000 in closing costs, the APR might be 6.4%. When comparing loan offers, the APR is the most accurate "apples-to-apples" metric because it reflects the actual impact on your wallet.
Standard Fees Included in APR:
- Loan origination fees
- Discount points
- Private Mortgage Insurance (PMI)
- Escrow/Settlement fees (varies by lender)