The “annual percentage rate,” or APR, is a measure used to determine the true cost of a loan. Instead of a bank or mortgage lender telling that your rate is 6.5% with $8,000 in fees, they’ll just say the annual percentage rate is 6.87% with those fees included.
The annual percentage rate was essentially created to prevent lenders from not disclosing fees that went into a loan to make the rate appear better than the competition. In other words, APR includes most of the other fees lenders charge during the loan transaction. These fees are then rolled into the interest rate to come up with the APR. However, it’s still not sufficient to choose a mortgage based on APR alone, because lenders do not include all the fees associated with your loan transaction.
APR also assumes a loan will be paid off after the full term of the loan, whether it be 15 or 30 years. Most homeowners hold on to their mortgage for a significantly shorter period of time, which will completely throw off the actual APR. Additionally, APR is not an effective measure between different products, only like products because of APR’s time dependency.
You will only see ALL the fees involved in the mortgage transaction by requesting the HUD-1 or the GFE, or Good Faith Estimate.
The following fees are usually included in APR:
The following fees are usually not included in APR:
- Title fees
- Escrow fees
- Notary fees
- Recording fees
- Credit report
- Appraisal report fee
- Home-inspection fees
- Doc prep fees
- Attorney fee
Be sure to review annual percentage yield, or APY, which banks use to figure out the cost or benefit of compounding interest.