What is APR?

A lot of first time homebuyers ask this question: “What is APR?” I have to admit that before I bought my first home I didn’t really understand what APR (Annual Percentage Rate) was and even lenders admit that it is a confusing number. In this article we’ll briefly discuss the ins and outs of APR to give you a better idea of how much your mortgage will cost you.

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Essentially, the APR is a measurement used to enable you as a borrower to compare different types of loan, from fixed rate loans to adjustable rate loans. They can be very useful in calculating the real annual cost of a loan. The APR is meant to protect the borrower from cheap tricks intended to mask the true cost of a loan such as hiding fees to suggest that a loan has a low interest rate.

To explain APR in understandable terms, it is probably best to give you a simple example:

Scenario

Let’s say that you borrow $100 over a 1-year term with an interest rate of 5%. In order to take that loan you must pay the lender a $5 fee. This means that the total cost of borrowing the money comes to $10. Now, while the interest rate of the loan may be 5%, the APR is actually 10%.

Now, apply this idea to a mortgage. If you borrow $100,000 at an interest rate (note rate) of 5% over 1 year (of course, you will rarely take a mortgage with a 1-year term, but play along for this example), your total cost to borrow the money will be $5,000. However, let’s say there was a loan origination fee of $1,000. Therefore, the total cost of the mortgage will come to $106,000 over the full term. This would make the APR 6%.

So it’s easy, really. The APR simply gives the borrower a better idea of the true cost of a loan, taking into account the additional costs and fees.