Is APR a Good Way to Compare Lenders?
When you are shopping around for a mortgage, car loan or any other type of credit, it is essential to compare the deals from one lender to another. Often, people will try to compare loan offerings among lenders by considering the interest rate that each lender is offering. However, because there are typically more costs associated with loans than just the amount of interest you pay, comparing loans by comparing their interest rates is not the most accurate way to compare.
As a result, some financial experts suggest using APR instead. However, it is crucial to understand that APR isn’t always a foolproof comparison method either, mainly if you use a stated APR quote and don’t consider the specifics of your situation.
What is APR?
APR stands for annual percentage rate. It is a method of calculating and evaluating the total cost in terms of what percent of the loan balance you’ll pay for the privilege of borrowing money, much like an interest rate does. However, when properly calculated, an APR considers every cost of the loan, including loan origination fees, private mortgage insurance, discount points, processing fees, and other annual fees.
Is APR a Good Way to Compare Lenders?
While an APR can be a better way to compare loans among different lenders, it is important to understand that even APR may not allow you an apples-to-apples comparison. While the APR should include most of the loan costs, some lenders may have fees and expenses that are not required to be included.
Finally, when an APR refers to a variable-rate product tied to a financial index, the APR calculation assumes that the index will remain the same for the loan duration. This, of course, is not the case as financial indexes will rise and fall, and the actual interest rate paid could vary significantly as a result of these changes.
When and How to use APR
Because of the problems with APR, it is vital to understand its limits and its uses. APR is best used for borrowers shopping for a mortgage who intend to keep the mortgage for an extended period and are getting a standard mortgage. You may also wish to use online APR calculators to determine your actual APR, taking into account all fees and costs, rather than relying on the APR numbers provided by your lender.
With these parameters and caveats in mind, APR can be a better way to compare loans among lenders than the interest rate and can be one of several factors you evaluate in determining which mortgage loan is right for you.
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