Also referred to as the Truth-in-Lending
Act, the Consumer Credit Protection Act included the government’s standards for annual
percentage rate
calculations. Ever
since then, all lenders are required by law to tell you
their annual percentage rate as well as their nominal
interest rate so that you can better compare one loan to
another.
It’s
best to think of the APR (annual percentage rate) as the
all-inclusive rate on a loan.
In addition to the stated interest rate on your
loan, it includes how fees, points and closing costs
affect the interest rate.
The
annual percentage rate is figured like this: You add up the
interest for one year and every finance charge.
With some loans, especially home mortgages, there can
be ten or twenty kinds of fees like appraisal, credit
report, processing, origination, etc.
Let’s
look at our $5,000, five-year loan at 5% interest, but this
time we’ll add a $100 processing fee. We are now borrowing
$5,100.
Our
monthly payment goes up to $96.24
(instead
of $94.36
shown in the first table),
and
our total interest becomes $774.60 (not $661.60).
The APR is 5.819%.
Loan
Amt
|
Fees
|
Term
(yrs)
|
Int.
Rate
|
Total
Int.
|
APR
|
$5100
|
$100
|
5
|
5%
|
$774.60
|
5.819%
|
$5000
|
$400
|
5
|
5%
|
$1114.28
|
8.218%
|
$5000
|
$115
|
3
|
4%
|
$436.55
|
5.515%
|
|
To compare APRs on the other two examples: a $5,000 loan at 5% interest over five years with a $400 origination fee has an APR of 8.218% (total interest of $1,114.28).
The other $5,000 loan at 4% over three years with a processing fee of $30 and an origination fees of $85 has only $436.55 total interest and an APR of 5.515%. In this case, the APR tells the story.
The government wanted APRs to provide a way of comparing loans, but APRs are not perfect. In comparing APRs from different lenders, the biggest challenge is in understanding the lender’s use of actual or estimated closing costs included in the APR calculation.
With “balloon
payment” loans, for example, you pay so much a month
for so many years, and then a big payment is due.
Credit card loans can be hard to compare because of things
like penalty fees, interest rates that can change, and other
factors.
With mortgages, fees like escrow, notary, attorney, home
inspection and many others are NOT included in the APR.
See what you learned.
Check out
"Verrry Interesting"and
"The Lowdown
on Loans" |