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Knowing About the Annual Percentage Rate (APR) Can Save You Money

How would you like a tool that gives you the ability to compare and pick the best loan? The good news is that such a tool exists, and it can save you thousands of dollars; the bad news is that few people take the time to understand or use it. This section shows you how to easily master the annual percentage rate (APR) and shop for mortgages with confidence.

When you look over the loan documents that a lender asks you to sign, you’ll notice that there are two interest rates. The first is a rate quoted by the lender when you ask for a quote and read their ad. However, when you and the lender get serious about a loan, and the paperwork with disclosures starts to appear, a second, higher rate is introduced, called the annual percentage rate, or APR.

The APR is calculated by taking the quoted interest rate—say, 6.0 percent— and adding in all the loan charges that the lender tacks onto the loan. That’s why the APR is always higher than the quoted or advertised rate. For example, suppose a thirty-year $200,000 loan with $1,199.10 in monthly payments is advertised at 6 percent.

However, this lender charges $6,000 in loan costs. When the loan costs are added ($206,000 in actual costs) and the interest rate is recalculated, keeping the payment and thirty-year payback the same, the interest rate jumps to 6.27 percent APR.

Federal law requires that, within three days of receiving a borrower’s loan application, all lenders disclose the loan’s APR along with a breakdown of loan costs. This disclosure is called a good faith estimate (GFE), and it includes a list of all the loan charges a lender tacks onto the amount of money you will get.

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