The APR can probably be the most confusing number tagged to a loan. The APR or the Annual Percentage Rate, is actually a simplified effort to show you that the finance related charges are rolled into the loan. The APR shows you the percentage of the loan that makes up your finance charges.
So if you have a $100,000 proposed loan, and the APR is let’s say 3.42%, then the total finance related charges in dollar amount is $3,420. You can shop this APR figure from lender to lender when seeking a refinance, but I wouldn't necessarily recommend that. I'll tell you why in this chapter.
Lenders typically advertise the APR because it is arbitrary and can be very ambiguous. The APR is widely confused with the “note rate” which is the interest rate that actually dictates your mortgage payment. Unlike the interest rate, the APR does not determine the amount of your payment. It only shows you the amount of your finance related charges.
Borrowers commonly seek the lowest interest rate from a lender and often times are responded by lenders showcasing the APR. This can be deceiving to a borrower because the note rate and the APR have the same numeric pattern.
An interest rate may read 5.25% where an APR may read 4.47%. The interest rate on a mortgage is indexed to prevailing market forces, such as the activity of 10 and 30 year bonds traded on Wall Street.
If you wish you know where 30 year interest rates are today, you can check any financial website or a periodical and look for mortgage rates 30 year average. Unlike the loan's interest rate or note rate, the APR is a cumulative number only pegged to the finance related charges proposed in the loan.
For example, you've seen an ad for an APR advertised “as low 3.42%” by a mortgage lender, and the average consumer will think that the 3.42% APR is the interest rate associated with the loan. 3.42% clearly looks like a great low number, especially when the prevailing market for mortgage rates may be in the 5% range (at the time of this writing).
What can be especially deceiving is that lenders may use catch words like APR's “hit record low” as if an APR is if the APR has a relation with the markets. APR's are not market driven so they won’t ever hit anything.
Remember, the APR is simply a number to show you the percentage of the loan that makes up your finance related charges. So the more finance charges you pay out of pocket, the closer the APR will be to 0%. If all your finance related charges are rolled into the loan, then the APR will obviously be higher, but not to exceed your particular states’ APR limit.
In most states, the APR cannot exceed 5% of the proposed loan. Other states, the APR can be as high as 8% of the proposed loan. There has been a more recent attempt by states such as in New York, to adopt a “sliding scale” rule of sort to fix the APR to a market driven index to give the APR a more free market feel. This has not had much consequence on APR practices.
In theory, if you are seeking a new loan based upon cost alone, you should be able to compare all of the proposed APRs you have received from lenders and pick the lowest number. Practically, this is not effective because there are many different factors that can interchangeably be included or with-held from the proposed APRs.
This can result in your confusion. The best way to compare APR’s from lender to lender is to also know the exact loan amount and payment tied to all of the proposed APR’s. Any significant difference in the make up any of the loan proposals you’re considering will render your APR comparison shopping meaningless.
Since the APR is only a number that shows you what the finance related charges in the loan are costing you, it should however, give you a meaningful starting point.
Auto companies also use the misleading APR to lure buyers into their show rooms by advertising 0% financing. However 0% does not mean free. 0% financing simply means that there is no finance charge rolled into the loan, but it doesn't mean that you will not be required to pay money out of pocket upon signing the final paperwork.
If you are propositioned with 0% financing for any loan you may have to come up with the equivalent of the finance charges up front in cash, or pay a higher interest rate so the bank can cushion their spread, so beware.
If you are financing, you simply will have finance charges. The question the APR raises is, how much is the financing costing you in dollars and cents? If the finance charges are paid out of pocket, then of course your APR would be 0%. If you roll the finance charges into the loan, then the APR would have a significant numerical value.
