Finance April 5, 2021

What Is Annual Percentage Rate (APR)?

Annual Percentage Rate or APR is the rate of interest charged on a loan, a credit card, or a separate credit line per year. It is a proportion of the overall balance to be charged. When you borrow money, all interest you pay raises your buying costs. Credit cards are a form of credit and understanding the APR for a card can allow you to compare deals and understand credit card payment costs. In addition, the APR allows you to compare card or loan offerings and to make other financial decisions.


The annual percentage rate or APR was created when the federal government attempted, years ago, to allow borrowers to easily compare the interest rate of various lenders. This equation would in principle make it possible for customers to choose the best deal. However, most of them, including many individual lenders, fail to explain what the APR actually means. When someone applies for a mortgage, they’ll receive no shortage of paperwork and one of the more prominent pieces included in that paperwork is the Truth in Lending disclosure (TIL).


The TIL tries to give a straightforward route for borrowers to compare rates. Unfortunately, since the APR stands out so prominently on the TIL, many consumers believe there is a “bait and switch” going on because the APR would be higher than the actual note rate on the mortgage. The note rate is one factor used to determine the monthly payment.


This is how it goes. A borrower receives a quotation from a loan officer, submits a request and a number of disclosures are transmitted within 3 days. The APR is excellent and is higher than the actual rate quote. When the borrower calls the credit officer and asks for a statement, a lot of credit officers fail.


Many times, the loan officer would tell you not to worry about the APR number, that it’s just a disclosure they have to provide. But the truth is, APR is the cost of borrowing expressed as an annual rate. This discrepancy can be easily explained by an experienced loan officer. The APR accounts for some of the closing costs associated with obtaining a new mortgage. Understanding the APR is another story. 


The difference between the note rate and the APR indicates which lender charges the most lender fees. Two mortgage lenders may quote the same 30-year rate, but their APRs may vary. How exactly does that work? If Lender A and Lender B both quote 3.5 percent for a 30-year rate, their APRs could be closer to 3.62 percent and 3.84 percent, respectively. Even so, the monthly payments are the same; the only difference is that Lender B clearly has higher lender fees than Lender A. In this scenario, Lender A tends to be the better choice.


Furthermore, when comparing mortgages with the same loan term, the APR can only be used as a comparison tool. An APR for a 20-year fixed cannot be compared to a 30-year note. The loan term is an important factor in determining the APR. The APR number is a useful method, but only if it is properly evaluated. When used correctly, however, the APR does still help customers. Remember, if a loan officer says it isn’t that necessary and has difficulty describing what it is, it might be time to look elsewhere for your financing needs.