What is an annual percentage rate (APR)?


The Annual Percentage Rate (APR) is probably one of the most misunderstood numbers borrowers should look at when they take out a mortgage loan. This is because the APR on a mortgage doesn't just show the interest or the monthly payment. It includes other costs as well, such as points, loan fees, closing costs, etc.

By definition, the APR expresses as a percentage the cost of credit on a yearly basis. What does that mean and why is the APR needed?

The APR rate of mortgage loans is a very important number because it can help you compare the costs of different loans. Lenders are required to quote it to their potential borrowers so that they can make informed decisions about the mortgage they apply for and be aware of the amount of interest that should be paid.

Whereas the annual percentage rate is very important when evaluating mortgage loans, it should not be the only factor to evaluate the quality of any loan or to compare the offers by two different lenders. This is because the APR does not include all fees and charges related to a mortgage. It can leave some very important ones, such as title insurance, appraisal, etc.

What fees are used to calculate the annual percentage rate (APR)?

The APR is estimated using a formula determined by the government. Typically, the following fees are used when calculating the APR:

  • Points
  • Buy-down funds
  • Prepaid mortgage interest
  • Mortgage insurance premiums
  • Origination fees
  • Various lender fees (such as underwriting, tax service, etc.)

As you can see, the annual percentage rate can be very useful when comparing different loans and can give you a rough indication which one is cheaper.

Mortgage rates hit their lowest since 1955. Ask the home loan experts we recommend Quicken Loans how to take advantage of them.
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