Whats the difference between the interest rate and the APR in a mortgage loan. How is ARP calculcated?

Take for example a 30-yr conforming loan at 5.5 interest rate and an APR of 5.98. What does that mean and what are the factors involved in determining APR.|||The APR calculation is compicated and there is a formula for it that I would challenge anyone in the mortgage business to really use correctly. However, a basic understanding of the things that impact the APR is helpful in insuring that you are comparing apples to apples in choosing a loan.





The APR factors in the pre-paid finance charges of a loan along with the note rate to arrive at the yearly cost of borrowing. Yes, it assumes that you will keep the loan for whatever the original term is so if you payoff a loan in 5 years vs. the term assumed in the APR calculation, the APR over the 5 years will be higher than what you thought originally. Basically, the less time you plan to be in a loan, the lower you will want the costs to be. Otherwise, you are paying for interest rate savings that you will never see.





First, lets assume that there is no private mortgage insurance involved. If the note rate was 5.5 and the APR was 5.98 on a 100K loan, your pre-paid finance charges would be about 5K. Essentially, it is costing you 5% to buy the rate down.





If PMI is involved, it also affects the APR calculation because it is assumed that you will have the PMI for about 10 years and, indeed, it increases the cost of borrowing. Lets say you are doing a 90% purchase, the PMI is probably a factor of 0.375 or so. Using the same example from above, we would subtract the PMI factor from the APR. Now, our pre-paid finance charges are much less of a factor as they are about $1200 so a majority of the difference between the note rate and the APR is explained by the presence of PMI.





From our first example, lets compare the 5.5% to a 6% loan with no (or minimal) pre-paid finance charges to see which is a better deal. At 5.5%, our payments would be roughly $568. At 6%, they would be roughly $600. So, why would you spend 5K upfront to save $32 a month? It would take 13 years before you actually started to save money. Less if you discount the $32 monthly savings. In fact, if you discount the savings at an average rate of 3%, it would take about 16.5 years to break even on the basis of net present value.





I hope that something that I have said will help to clarify the difference between the note rate and APR.





If you have any follow up questions, you can email me through the link in my profile.|||No, I don't want your example, I'll use my own.





The APR is the "effective" interest rate on the loan, considering all "prepaid items".





Look at it this way. Say you're borrowing 100,000 for one year, and you are going to pay 12 per cent with no up front fees. At the end of the year, you repay 112,000, interest is 12 per cent, APR is 12 per cent.





Now, say you could borrow at 10 per cent, but the prepaid charges are 3,000. According to the Truth in Lending, you're getting 97,000, and you'll repay 110,000 at the end of the year. Interest rate is still ten percent, but the APR is 13.5 or so, because you're paying back 13,000 more than you actually received.





If that doesn't make sense, email me.|||Another answer is this: Say you borrow $100,000 at 5.5% for the loan for 30 years. But if you also have to pay $3,500 in fees to obtain that loan. So assume you keep the loan for 30 years you are paying the interest plus the fees which ends up being more like 5.98%. APR (annual percentage rate) is your "effective" rate with all the fees included assuming you kept the loan for the entire term.|||APR includes hidden costs and transaction fees so it's a better comparison tool. Check out source for detailed explanation and similar example.