Interest Rate and Annual Percentage Rate

When shopping for a loan, you want a way to evaluate the cost of one loan against another to make sure you are getting the best deal.  Lenders will quote both an interest rate and the APR.   The interest rate is the amount that is used to determine what your payments to the lender will be.  The overall cost of a loan goes beyond just the interest rate and includes costs such as points, broker fees and other fees required to open the loan.  The APR is the total cost of the loan expressed as an yearly percentage rate over the life of the loan.  

 A smart consumer will always ask what the interest rate and the APR are in comparing one loan to another.  The loan that offers the lowest interest rate is not always the best deal.   As an example, you are shopping for a $200,000 mortgage loan with a term of 30 years.   You contact three lenders and ask for a quote on the same product.  Lender A and Lender B each quote you a fixed rate of 4.75%. The monthly principal and interest payment would be $1043.29 from each lender.  Lender C quotes a fixed rate of 4.5% with the monthly payment being $1013.37.  It would appear that Lender C has the best loan product.  Not necessarily.  We now have to compare the APR from each lender.

 Lender A will charge fees for this loan of $800.00, so the APR for this loan is 4.785%. Lender B is charging a discount point for the 4.75% rate so the fees would be $1800.00 and the APR is 4.828%.  Good-bye Lender B.

Let’s take a closer look at Lender C.  The monthly payments will be $30.00 less each month.    Lender C is charging an origination fee to give you that lower rate.  The total lender fees from Lender C are $2,800.00 and the APR is 4.619%. 

So which loan is the best loan?  That depends on the consumer.  With Lender C, you will need to pay $2,000.00 more in closing fees than with Lender A to get the loan that saves $30.00 per month.  You would have to keep that loan at least 66.6 months (5 years and 7 months) to recoup the additional $2,000.00 you paid in fees. 

The APR does not include additional costs associated with any financing that are necessary costs, usually referred to as third-party fees. In the example of financing a mortgage, these costs include title searches, title insurance, recording fees and government fees. You, as a consumer can shop for things such as title insurance, but recording fees and government fees will be the same regardless of which lender you select as those are determined by your state.

By comparing all the costs of a loan, you can make the decision on which loan product is best for your needs.