What You Need to Know about APR

The Federal Truth in Lending Law created the APR as a means of leveling out the playing field of lenders for potential loan borrowers. It was intended to portray the true annual cost of a loan in the expectation that consumers would be able to compare loans across a level playing field. It should include all of the costs associated with taking out the loan that the APR is attached to.

When borrowers compare loans using only the interest rate that is charged on the balance of the loan, it does not present an accurate picture of the true cost of the loan. It only represents one fee that is associated with the loan. Various fees are charged whenever someone takes out a loan and these costs should also be included. Therefore, the APR is designed to reflect the annual cost of a loan. Unfortunately, some lenders still advertise low interest rates in an attempt to lure customers while hiding exorbitant fees and associated costs. This happens because the APR is not calculated in the same manner across the board.

Plus, using the APR for comparative purposes only works when similar loans are compared. For example, comparing the APR on a 15-year mortgage with the APR on a 30-year mortgage is not going to reflect an accurate difference in the cost for each of these loans. When the APRs on two or more loans are calculated similarly, it is fairly safe to say that the loan with the higher APR will have a higher annual cost than the other loans.

What Does the APR or Annual Percentage Rate Include?

Unfortunately, although certain guidelines are in place detailing the types of information that should be included in the APR calculation, many lenders use a formula of their own design. This means that while some lenders include all of the costs associated with the loan, others find ways to get around doing so.

In general, the following fees are usually included in the APR by all lenders: the loan processing fee, document preparation fee, underwriting fee, private mortgage insurance, (if applicable), discount points, origination points, and pre-paid interest amount. Fees that are occasionally included in the APR are the cost of credit life insurance and the loan application fee.

Fees that are sometimes, although rarely, included in the APR by some lenders are the attorney fee, notary fee, title fee, recording fee, escrow fee, credit report, appraisal fee, transfer taxes, document preparation fees, and home inspection costs.