Many of the home buyers, especially the first time home buyers, are not aware of the various terms associated in a mortgage process. For instance, the difference between the annual percentage rate (APR) and the rate of interest is not very clear to many prospective home buyers. When you are in the process of taking out a mortgage loan, you see the interest rate alongside the Annual Percentage Rate advertised by the lender. In fact, as per the Federal Law, lenders are required to mandatorily reveal the APR of a loan to the lender. It gives an estimate of the true cost of a loan.
Rate of interest defined
Rate of interest is the amount charged by a lender, expressed in percentage terms, for the use of funds offered by the lender. Usually, rates of interest are calculated on an annual basis. Lender charges interest throughout the term of the loan. Usually, borrowers pay the interest on a monthly basis along with the repayment of the principal loan amount. Rate of interest on a mortgage loan is determined on the basis of several complicated macro economic factors and it reflects the overall economic situation in a country.
APR defined
APR is a rate which gives an indication of the effective cost of a loan. In a mortgage loan, the APR is more than the rate of interest. APR is a broader indicator of the borrowing costs as it includes the rate of interest as well as the other costs associated in a mortgage loan. As per the Truth in Lending Act (TILA), lenders are required to reveal the APR of a loan before offering it to a borrower. Anyways, you – the borrower, can calculate the APR of a loan by using an APR calculator. APR calculators are available online. You can select one calculator on your own and find the APR of a loan by using it by inserting the relevant information. This is indeed a very good tool to compare different mortgage loans.
APR is a better indicator of the borrowing cost of a loan. Along with the mortgage rate of interest, it includes some additional costs. Some of these costs are discount points, origination points, private mortgage insurance (PMI), loan processing fees, prepaid interest, underwriting fees, document preparation fee etc. All these costs have to be incurred by a borrower while taking out a mortgage loan. Since APR incorporates all these costs, it is certainly a better indicator of the true cost of a loan.
It is very important that before taking out a mortgage loan, you should be well aware of the different mortgage terminologies along with their implications. Before you select any mortgage deal, you should know the mortgage rate as well as the APR of the loan. If you know the APR, you can make a comparison on different mortgage loans. This actually helps you make a better mortgage buying decision.