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December 3rd, 2010

Reader: “What is the difference between ‘rate’ and ‘APR’?”

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APR Recently, a visitor to HSH.com had a question which they submitted in our “Ask the Expert” section. Their question was, “What is the difference between ‘rate’ and ‘APR’?”

Here was our answer:

APR is perhaps the most misunderstood part of mortgage finance. “Rate”, or more properly “contract interest rate” is the actual rate of interest you are being charged. If it costs you nothing to get your loan — that is, there are absolutely no costs whatsoever — your interest rate and APR would be identical. However, mortgage loans do have fees, and paying them means that your actual cost of credit is higher.

Here’s why: If you want to borrow $100,000 at 4%, your contract will say 4%, and your monthly payment on a 30-year term will be $477.41 per month. If there are no costs at all to obtain the loan, your APR will be 4.00%

However, if it cost you $2,000 to get the loan, you didn’t actual net $100,000 from the lender, but rather $98,000 instead. Your monthly payment, by contract, is still $477.41 – and making a $477.41 per month payment on a $98,000 loan translates into an interest rate of 4.16%, which is your actual cost of the loan — and your APR.

Please know this is a simplified example. What does or does not get included in the calculation of APR is affected by lender refund policies and more. As such, it’s possible for two seemingly identical loans to have different APRs!

The calculation is far more complicated for ARMs, and doesn’t properly account for today’s products where the initial interest rate is higher than even the calculation of the sum of index + margin, which governs the interest rates for future loan changes.

Do you have a question that you would like someone at HSH.com to help you answer? If so, submit it in the “Ask the Expert” section of our homepage (located on the right-hand side, just below the “Mortgage News Today” section).

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One Response to “Reader: “What is the difference between ‘rate’ and ‘APR’?””

  1. Tweets that mention Reader: “What is the difference between ‘rate’ and ‘APR’?” | HSH Financial News Blog -- Topsy.com Says: December 3rd, 2010 at 8:27 pm

    [...] This post was mentioned on Twitter by HSH Associates, Mortgage News. Mortgage News said: [HSH] Reader: “What is the difference between ‘rate’ and ‘APR’?” http://ow.ly/1aiapD [...]

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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