Annual Percentage Rate, Fees, and Uses
The annual percentage rate is made or charged within a period of 1 year. Financial institutions charge interest on loans, credit cards, and other financial products. Savings accounts and other investment instruments pay interest.
Differences between interest rate and APR
APR includes one-time fees and shows the rate that bank customers pay on loans and credit cards. The interest rate is a fee on a borrowed amount, which doesn’t include annual fees and other transaction costs.
APR and Fees
Certain costs are not included in the annual percentage rate, including service reinstatement and late fees. Fees that borrowers pay to other parties, including estate agents and lawyers, are not included. Private mortgage insurance is usually included in the loan amount when borrowers make a down payment of less than 20 percent.APR also includes document preparation, notary, and attorney fees. There are origination fees for processing loan applications. The fees vary between 0.5 percent and 2 percent and cover document preparation and underwriting. Pre-paid interest and points are also included in the APR. The rate may also cover life insurance premiums and application fees. This depends on the bank and the financial product. Other fees are usually not included in the APR, among which title fees, credit report costs, home inspection, and appraisal.
The annual percentage rate helps consumers to compare loans and make wise financial decisions. For example, if a loan has a rate of 15 percent, this means that you will pay $15 for every $100 you borrow. You should check whether any fees are included and what types. One-time upfront charges can increase the cost of borrowing. To illustrate, a borrower applies for a loan of $200,000 at an interest rate of 6 percent. The borrower has $2,500 in closing costs. The yearly rate will be 6.25 percent.
Note that different financial institutions quote annual or monthly interest rates, which makes comparison more difficult. Some lenders offer a low interest rate but charge high annual or upfront fees. Others advertise low or no fees but include them in the interest rate. This is where the APR comes handy because it includes all fees that borrowers pay during the loan term. If you borrow $100 and the APR is 8.5 percent, you will pay a total of $8.5 in fees and interest.
APR, EAR, and AER
Financial institutions usually advertise a typical APR, but this doesn’t mean that every applicant is offered the same interest rate. The rate and terms depend on the borrower’s income, loan-to-value ratio, and payment and credit history. As a rule, banks offer their typical APR to 2/3 or 66 percent of their clients. The annual percentage rate is usually higher for mortgage loans because many financial institutions charge administration fees. Some lenders quote EAR or equivalent annual rate whereby the rate is set up on a comparable basis. The EAR does not include charges for overdrafts but gives borrowers an idea of the cost of going overdrawn. The annual equivalent rate or AER is different in that borrowers pay interest charges on a higher account balance. Financial institutions usually quote AER on current and savings accounts for which the balance is in credit.