What is the Annual Percentage Rate (APR) and Why is it Flawed? An annual percentage rate (APR) reflects the mortgage interest rate plus other charges. There are many costs associated with taking out a mortgage.
♣ The interest rate
♣ Other charges
The interest rate is the cost you will pay each year to borrow the money, expressed as a percentage rate. It does not reflect fees or any other charges you may have to pay for the loan.
An annual percentage rate (APR) is a broader measure of the cost of borrowing money than the interest rate. The APR reflects the interest rate, any points, mortgage broker fees, and other charges that you pay to get the loan. For that reason, your APR is usually higher than your interest rate.
If you have applied for a mortgage and received a Loan Estimate from one or more lenders, you can find the interest rate on page 1 under “Loan Terms,” and the APR on page 3 under “Comparisons.”
APR is very misleading and often points to the wrong option for borrowers.
- – APR assumes that borrowers will have the loan for its entire duration. Therefore, no prepayments, refinances, or selling of the home for the entire life of the mortgage.
- – APR assumes inflation will remain constant at zero, as it does not contemplate the current value of money being worth more than dollars being paid back 20 or 30 years later.
- – APR assumes a constant rate of interest, which can cause trouble when considering adjustable-rate mortgages (ARMs). Because the interest rate on an ARM is uncertain once the fixed-rate period is over, – APR estimates can understate the actual borrowing costs if mortgage rates rise in the future.
- – Perhaps worst of all is the way APR treats interim interest.
We all know that this is a temporary cost that gets washed by the next first of the month, yet APR considers it a lender fee. This also makes APR prone to manipulation. One lender may assume a closing at the beginning of the month, while another lender could assume a closing at the end of the month. This would result in different APRs, even though the terms of the loan are the same.
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