The topic of APR is broad. So, I’m going to give you the explanation I use with my borrowers. To start with, APR stands for Annual Percentage Rate and for clarification, it is NOT an interest rate, it’s the total cost of the loan expressed as a rate. Many people confuse APR for the interest rate and mistakenly believe they are going to be charged interest based on the APR.
Let’s do an example:
If I lent you $100,000 and the only thing I charged was interest at a rate of 4% then the cost of the loan would be $71,869 (over a 30 year term). In this case, the APR would also be 4%. Again, the only thing charged was interest so the APR would equal the interest rate.
Now, let’s say I charged you 4% interest plus an origination fee of $1,000. Now the total cost of the loan is $72,869 (71,869 interest + 1,000 origination fee). Now the APR would higher at 4.083% because it’s the cost of interest (4%) plus the origination fee.
So when you are shopping for a loan, remember that APR is not your interest rate, it’s a rate that is designed to help you see the total cost of the loan. So as you shop for your mortgage, remember to compare the interest rate to the APR. The greater the difference between the interest rate and APR, the greater the potential cost.
APR can be confusing so if you have questions, let me know.