What Is APR?
Now that we’ve covered interest rates, let’s dive into what APR is and why you should care.
APR in an acronym for annual percentage rate. Said differently, APR is the total cost associated with borrowing money yearly. This is a more encompassing way to measure the true cost of borrowing money from a lender.
How Does APR Work?
The annual percentage rate (APR) is made up of; the interest rate, any fees associated with borrowing money, any discount points the lender associates with the loan and various other charges you’ll be required to pay on the loan.
How Does APR Get Calculated?
APR gets calculated by adding up the total principal balance of the loan, the interest rate on the loan, and the various fees associated with the loan into one final total. Once that number is finalized, you divide that number by the duration of the loan, and convert that total into a percentage of the total loan value.
A $300,000 loan that has $10,000 in fees and a 4.5% interest rate actually has an APR of 4.71%. The 4.71% is the true cost of borrowing money, and as shown, the APR is always greater than the interest rate.
Calculating the numbers by hand or excel is a thing of the past. There are various online calculators that can help you understand your true APR rate by just inputting a few numbers.
How Do I Calculate APR From Interest Rate?
The interest rate is needed to calculate the annual percentage rate because the interest rate is added to the total fees paid, and the principal balance, to get one final aggregated number. From there, that total is divided by the number of days in the loan, multiplied by 365 and again divided by 100 to convert that number into a percentage. That percentage is your APR.
Is It Better to Have a Lower Interest Rate or a Lower APR?
Generally speaking, the APR is a more accurate representation of the true borrowing cost of the loan. The lower your APR is, the less expensive it was to borrow the money.
A lower interest rate may be easier on the eyes, as the monthly payment will likely be lower, but don’t be fooled. There may be high fees or costs associated with borrowing, which allows the lender to offer a lower APR
Read all about the hidden fees you may not even know you'll have to pay when getting a mortgage.
Does 0% APR Mean No Interest?
There are various times a lender may offer a 0% APR. The 0% APR is generally for a limited period of time, meaning the borrower may borrow the money for 12, 18, or even 24 months interest fee.
Once the time period has elapsed, interest becomes relevant with the loan and the borrower will be required to pay the interest expense associated with borrowing.
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Now You Know the Difference!
There are certainly a lot of terms and acronyms in the mortgage, finance, or lending field. As a borrower, it’s important to fully understand what these terms are, and how they can impact your monthly payments.
Remember, the interest rate is the cost to borrow the principal amount of the loan, but it does not factor in all expenses. For a more encompassing and detailed understanding of the borrowing cost, use the annual percentage rate, or APR.
The APR is the fully baked financial metric that factors in the all in cost of the loan. The APR will add in the interest, closing fees, and broker fees into one aggregated sum, and divide that amount over the lifetime of the loan. That payment is converted in a percentage, which you’ll know as the APR.
