Annual Percentage Rate

The Annual Percentage Rate, or APR, is a measure of the true cost of a loan.  The Federal Truth in Lending Act requires mortgage companies, and other lending institutions, to provide the consumer with the annual percentage rate.  This allows consumers to make comparisons between institutions, or within an institution.

Unfortunately, there is a lot of confusion surrounding the use of the annual percentage rate information.  For example, the APR is not used to calculate a monthly loan payment. A monthly payment is calculated based on the interest rate charged and the term, or length, of a loan.

The annual percentage rate helps the consumer figure out the impact that additional loan fees, such as application fees, have on the total cost of the loan.  A simplified formula for APR takes the following form:

Annual Percentage Rate = Interest Rate on Loan + Loan Fees

The APR calculation effectively adds the fees to the loan amount, thereby increasing the amount borrowed.   A good example is mortgage points.  Since the APR accounts for fees, which can vary from loan to loan, it is a good measure of the effective cost to the consumer. The lower the APR, the lower is the total cost of the loan to the consumer.