Terms Borrowers Should Understand - Interest Rates & APRs

By Jeff Randolph

If you are new to buying a house, borrowing or have made some mistakes when in the financial market, you might consider learning the lending terms. You hear the words interest rates and APRs and usually your first instinct is to nod you head and think, "whatever", because ultimately you need the money. However, interest rates and APRs have a major impact on the loans we take out and can also affect our ability to pay back our obligations. Therefore, if you are considering working with a creditor, read up about the details of interest rates and APRs so you can be an educated borrower.

It is not uncommon to assume that interest and APRs are the same thing, because both of them relate to fees we incur for borrowing money. However, although they may seem similar, they are actually different and it is important not to confuse the two. Understanding the difference will help you understand whether or not you will be able to pay back the loan or not, and that will be imperative when you decide whether or not to actually borrow from the lender.

Interest is something that most people seem to understand because it is a lot less complicated than APRs. Basically, it is the fee we incur because we decided borrow money, and it is determined based off the amount of principal for the loan and the term of the loan. Although interest is mainly determined off the principle and term, there are other details that could affect your interest rate.

One of the biggest factors that affect the interest rate is the type of loan you take out with the bank - fixed loan, ARM loan, etc. In addition, your interest rate can also vary depending on the amount of your loan versus the value of your home. Also, many times interest is evaluated based off the type of property you decide to purchase. Depending on whether you are purchasing a home for a primary residence, secondary residence, or investment property, the interest rate can vary.

Most people do not realize this, but you can actually "buy down" your interest rate by paying points up front. A point is equal to 1 percent of the loan you are buying; therefore if your loan was $100,000, you could "buy down" your interest rate by paying an additional $1000. When you "buy down" your interest rate you reduce the amount you will be paying in the long run and there are actually possible tax benefits that come with it.

If you do not know how to calculate interest, it is actually quite simple. You divide the total amount of interest charged from the loan by the total amount of the loan; therefore, if your lender loans you $10,000 and charges you $100 in interest your interest rate is (100/10000) x 100 percent = 10 percent. Computing interest rates always simple, even if the numbers are a little bit more complicated.

Besides the interest rate, APR (annual percentage rate) is also discussed frequently when it comes to lending. The APR is calculated annually and it includes the total closing costs and interests over the entire term of the loan; therefore, many believe that it is a better indicator of the expected costs of the loan. When you look APR, you tend to overlook costs that may come up in the future.

Since APR considers all costs for the future other than the principle, not just the interest rate, it is usually a higher rate than the interest rate. The calculation for APR is a little more complex than the simple calculation for interest rates and it usually involves an amortization schedule and a more complicated equation. However, because of this APR is a good prediction of future costs.

When you apply for your mortgage loan both rates, the interest rate and the APR are involved. The actual rate will depend on the market conditions at the given time and your credit history. Regardless of the changing rates, understanding the two terms will help you to more effectively choose the right mortgage.

Also, although you may not have much control on the interest rates and APRs at the time, you do have more control on the controlling costs that come with your new mortgage. These costs are usually the initial cost like closing costs and mortgage insurance. Make sure to negotiate them with your lender because they have flexibility with them.

As always, now that you are more informed regarding the terms and practices of lending, it is always wise to shop around. Although the first lender may be willing to give you a loan, it may not be right for you. Do you research and find the best fit for you.

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