Question 1

What is the difference between interest rate and APR?

Accepted Answer

The interest rate is the cost of borrowing the principal amount, expressed as a percentage. APR (Annual Percentage Rate) includes the interest rate plus all fees and costs associated with the loan, giving you the true cost of borrowing. A loan advertised at 6.5% interest might have a 6.85% APR once origination fees, closing costs, and points are factored in. APR is the more accurate number for comparing loan offers.

Question 2

How is APR calculated?

Accepted Answer

APR is calculated by finding the interest rate that would produce the same monthly payment if the borrower received the loan amount minus all fees. Mathematically, it is the rate where the present value of all payments equals the net amount received by the borrower. This calculation uses an iterative method (similar to Newton's method) because there is no simple formula for APR.

Question 3

What fees are included in APR?

Accepted Answer

APR typically includes origination fees, discount points, mortgage broker fees, closing costs, and other lender charges. However, not all costs are included — prepaid interest, appraisal fees, title insurance, and some third-party fees may be excluded depending on the lender and loan type. The Truth in Lending Act (TILA) requires lenders to disclose APR, but the exact fees included can vary.

Question 4

Why would I pay discount points to lower my rate?

Accepted Answer

Discount points are upfront fees paid to the lender to reduce your interest rate. One point typically equals 1% of the loan amount and lowers your rate by about 0.25%. Points make sense if you plan to keep the loan long enough for the monthly savings to exceed the upfront cost. The break-even period is usually 4-7 years. If you plan to sell or refinance before then, points may not be worth it.

Question 5

Should I always choose the loan with the lowest APR?

Accepted Answer

Not always. The lowest APR usually means the lowest total cost over the full loan term, but other factors matter. A loan with a slightly higher APR but lower monthly payment might be better if cash flow is tight. Similarly, a loan with a lower APR but high upfront fees only saves money if you keep the loan long enough to recoup those costs. Consider your timeline, budget, and financial goals alongside APR.

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