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Open a newspaper and you're likely to see an advertisement for a lender announcing their mortgage terms and rates. Sometimes the ad will include both the interest rate and the Annual Percentage Rate or APR. You may wonder, “What's the difference?”
The interest rate is the percentage of the loan amount the lender is charging you to borrow the money. It does not include other, less obvious, charges like interest and fees. The Federal Truth in Lending Law requires all banks and lenders to also advertise the Annual Percentage Rate because it is a more accurate reflection of the cost of the loan. The APR incorporates other costs and calculates them as a yearly percentage of the loan amount. When shopping for a mortgage it is the APR that allows you to more easily compare and contrast loans. It is designed to standardized the components and allow for an apples to apples comparison. The following fees are generally included in the APR calculation:
• Points – This covers both discount and origination points. Origination points are fees charged to cover some of the cost of providing the loan. Discount points are pre-paid interest that can be used to “buy” a lower interest rate.
• Loan Processing Fees – A charge made by the lender for accepting the loan application and gathering the necessary documentation.
• Private Mortgage Insurance (PMI) – This additional insurance is typically required by lenders for customers who provide less than a 20 percent down payment.
• Administration or Underwriting Fee – The cost for assessing the risk involved in lending to you. This includes the review of your credit, employment history, debt and other factors..
• Prepaid Interest – Different from a discount point, this is interest paid at the closing that covers from the day the loan commences to the date of your first mortgage payment.
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