The APR

Probably one of the most confusing things about mortgages and other loans is the calculation of interest. With variations in compounding, terms, and other factors, it's hard to compare apples to apples when comparing mortgages. Sometimes it seems like we're comparing apples to grapefruits. For example, what if you want to compare a 30-year fixed-rate mortgage at 7 percent with one point to a 15-year fixed-rate mortgage at 6 percent with one-and-a-half points. First, you have to remember to also consider the fees and other costs associated with each loan. How can you accurately compare the two? Luckily, there is a way to do that. Lenders are required by the Federal Truth in Lending Act to disclose the effective percentage rate as well as the total finance charge in dollars.

The annual percentage rate (APR) that you hear so much about allows you to make true comparisons of the actual costs of loans. The APR is the average annual finance charge (which includes fees and other loan costs) divided by the amount borrowed. It is expressed as an annual percentage rate -- hence, its name. The APR will be slightly higher than the interest rate the lender is charging because it includes all (or most) of the other fees that the loan carries with it, such as the origination fee, points, PMI premiums, etc.

Other Things to Consider

Here are some other things to take into account when you look at the APR.

The more you are financing, the less impact all of those fees will have on the APR, simply because the APR is calculated based on the total loan amount.

The length of time you are actually in the home before you sell or refinance has a direct influence on the effective interest rate you ultimately get. For example, if you move or refinance after three years instead of 30, after having paid two points at the loan closing, your effective interest rate for the loan is much higher than if you stay for the full loan term.

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