This is a relatively simple question with a very complicated answer. The true definition of this one even puzzles some very experienced loan officers. There is a generally accepted brief version of the answer that even experts use. The bad news is that, in order to truly understand, let alone be able to explain the calculation for APR, a truly long and complicated answer is the only option.
For those of you not interested in long and complicated, here is a very serviceable and very brief definition: APR is the true cost of money over time.
In other words, your mortgage has a NOTE rate, or the interest rate on your loan, but it also has closing costs, prepaid interest, and other finance charges. The APR is the cost of your normal interest and those finance charges over time expressed as an interest rate relative to the rate you are paying on your mortgage.. got it?
APR is commonly used to compare the costs of loans.
You can compare two loans by looking at the APR, right? Only if you compare apples to apples – which is a challenge.
Lenders have some wiggle room when they calculate APR for you. They may or may not include some of the costs you’ll pay. For example, the credit report fee, appraisal fees, and inspection fees may not be included in your APR quote. Since different lenders can charge different credit report fees, the APR comparison becomes less valuable.
An honest lender will include more fees that accurately reflect your circumstances, which makes their APR appear higher. Don't just dismiss what appears at first glance to be the more expensive loan. It could be you're turning away the lender who was more conservative in their estimates of fees. Always ask for the breakdown of fees used to calculate the APR before making a decision based on the APR.
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