Just see the world with the holy heart

APR vs Interest Rate

Whenever I wished to compare loan quotes, I was always baffled by the confusing financial jargon, like APR, interest rate, points, closing costs, etc. For all those that go through the same trauma while loan hunting, I have an article explaining 'annual percentage rate vs interest rates'. Here's a low down on Annual Percentage Rate or APR vs interest rates...

Till I started my full fledged finance studies, I always thought that Annual Percentage Rates (APR) and interest rates were one and the same thing, just results of different calculation methods. Now I know that such is not the case. So here I am, trying to relieve you of all your similar doubts about APR and interest rates, through this 'APR vs interest rate' article. This APR vs mortgage interest rate article should help you in understanding the APR and interest rate difference as well as the annual percentage rate formula. Read more on loan calculators.

Simple Mortgage Interest Rates
Interest rate is a simple percentage figure that stands as the basic borrowing cost on the principal borrowed. The interest amount is a direct percentage of the actual amount of borrowed funds. In other words, interest rate is the rent compensation paid by the borrower to the lender to compensate for his opportunity cost of lending you that money, as opposed to investing it elsewhere. Interest rates are usually the ones taken into account when making initial comparisons between various loans, as they directly affect the monthly payments of the borrower, something that most debtors are most concerned with.

Though low interest rates are the first thing that people look for when hunting for good deals on loans, interest rates are usually not the only monthly expense that goes towards the loans. As there is usually a trade-off between interest rates and other upfront costs of acquiring the loan, i.e. lower the interest rates, higher the associated costs and vice versa, just hunting for a low interest rate deal is not always the most beneficial option. This is where the APR comes into the picture.

Annual Percentage Rate (APR)
The best way to explain an APR to a layman, is to say that it represents the 'true cost of his loan'. The basic difference between APR and interest rate happens to be just this - while the interest rate is just the intrinsic borrowing cost, calculated as a percentage of the loan amount, the APR includes the other associated loan expenses that usually cannot be seen from the actual interest rate figures. In simple terms, APR is nothing but another representation of the effective rate of interest that the borrower will be burdened with, and so, the APR is always higher than the normal interest rate.

Theoretically, all fees required to finance the loan are incorporated into the calculation of APR, but as different lenders incorporate different fees and leave out different ones, not all lenders with similar loan terms and conditions reach to the same APR. Either way, whatever the expenses to be taken into account, the APR calculation requires that all such amounts be totaled and amortized over the entire loan period. The new rate calculated after included all such additional payments into the interest rate calculation is what is known as an APR. Know more on amortization.

While the APR covers all the drawbacks of the normal mortgage interest rates, APR in itself also has a few limitations of its own. For one thing, as already mentioned earlier, as there are now clearly cut out rules as to which expenses to include and which to leave out in the APR calculation, most lenders choose the expenses to suit their ends. Expenses usually not considered in the APR formula are home appraisal expenses (home loans), title fees, and credit reporting fees. It is always better to ask your lender for a disclosure of expenses included and excluded in the calculation. Secondly, APR does not work well for adjustable rate loans as all calculations are usually based on future interest rate forecasts which may not be so accurate.

Last but not the least, before you go out and grab a loan at a lower APR, consider this. Since APR amortizes all associated expenses as well as the original interest payments over the entire life of the loan, the only way such a deal is profitable is when the loan is actually held all the way to maturity. For example, if you have a plan in mind to settle a loan of 10 years in 5 years itself, looking for a low interest rate (despite a little higher APR) may be viable in your case. If you plan to refinance or retire your loan early, higher up front cost may actually turn out to be a bad deal for you, as these will unnecessarily be amortized over the entire loan period. Know more on mortgage refinance.

APR vs Interest Rate
Here are a few APR vs interest rate facts:
  • 'Truth in Lending Act', a federal law requires that both, the APR and the interest rates, be simultaneously disclosed to the borrowers, to protect them in credit transactions through a full and fair disclosure.
  • In financial terminology, while the interest rate is just the 'pure cost of money', APR includes all additional costs that make it the 'true cost of money'.
  • While traditional interest rates exclude transaction costs and other fees in their calculations, the APR includes most of them. This makes APR a better indicator of how much the borrower is actually ending up paying to the lender, in compensation for his loan.
  • Because of the inclusion of additional costs, the APR is always higher than the nominal mortgage interest rates.
  • Loan comparisons using APR are more accurate than comparisons made on interest rates, for a low interest rate loan usually has higher other associated costs and vice versa.
  • Judging a book (loan) only by its cover (APR) is also not a prudent strategy, as an APR analysis does not reveal things like balloon payments, prepayment penalties and rate lock-in periods.
Anyways, this was all the information I had on the topic of 'APR vs interest rate. Hope it helps you make wise loan decisions. Remember, always be prudent when raising large amounts of debt. Be prudent and remember my 'APR vs interest rate' article, every time you go loan hunting.

1 comment:

  1. The article talks about the definitions of interest rate & annual percentage rate (APR). The difference between these two financial indicators have been explained in a very simple way. It has also explained how APR is calculated. The limitations of APR have also been explained. Anyways, it is to be noted that APR is a much better indicator of the true cost of a loan than the interest rate. The costs of a mortgage loan encompass many fees including the interest rate. While comparing different mortgage loans, APR is a better measuring rod than the interest rate. As a borrower you can calculate the APR of a loan by taking the help of an online APR calculator.


Hello (^-^)v

Search Here

Custom Search


accounting airline airplane airways alchemy alien android animal artist automotive baby beatle beauty betelguese blackjack business cancer car car insurance cartoon casino castle caterpillar celebrity cellophane celluloid century change cheap chess child china christmas city claim clinton coffee come from comment computer console cook cookies coral cosplay county credit cards cricket culture dating dead definition design diet disaster divers dofollow domain drive drug dwarf ear earthquake easy education effect egyptian elephants exchange link family fancy-free farming fashion fat finance fingerprint first installed first killed first plastic fish fitness flare flight flower follow your comment food footloose forex free gadget gambling games geology ghost gold goldfish golf Google gossip goverment great wall grow gypsies hair harvard hawaii head header health Healthy Life hear heavy metal herbal herbs himalaya historic sites historical history history of naruto hocus pocus hollywood hollywood sign home honeybee hormon hotels in hollywood how how long human body idea insect Inspire insurance introduced invented invest island japan japannesse jet jewelry job junk ken uston kids kitten knowledge konoha ninjas law Lawyer learn lego liberty bell lion loan logo love lyrics magician magnetic mail mammoth many market meal medical memoriam metal gallium metallica mining miracle mistery money mortgage mosquito mountain move murderer music Music Artist myth naruto history nature navigation neuron star new year news nike nobel prize not a sloution notification obama old olympic online online business orchid ornament other paid to click painite. gem painting party patent pendet dance people pet piranha pizza planet plant poem poker prediction presentation queen railway rare reborn recycle religion retouch river rockwalk romantic salmon scotch sea seat seating sell SEO Space sport star strange moment street study success people sunrise swoosh symbol tape tari pendet tax tea keep technology term tickets tips toothpick tour de france tourism tourist toy travel traveling children trend tsunami tusk twins usa uzumaki naruto vacation vegetable venus video visit Indonesia war water west what are wild wine wolly woman word work wright ಬ್ಲೂ ಚಿಪ್

Popular Posts

Copyright © Vision in memorial. All rights reserved. Template by CB