What is an Annual Percentage Rate (APR)?

An APR on a mortgage is often confused with the interest rate, and although it's similar in that it gives the borrower an idea of what the cost will be, it is actually a good metric for comparing different mortgage loans. The annual percentage rate takes into account all of the different fees associated with taking out a mortgage, such as points, interest rates, etc. and incorporates them into a single number to better characterize the cost of a mortgage.

When Josh came to me frustrated and overwhelmed about which mortgage to choose, I explained to him that the APR can be a handy tool for assessing the different offers he has. It weighs the fees associated with a mortgage or refinance along with the offered interest rate accordingly, into an approximately equivalent single interest rate. For example, Josh has the following two offers: a $150,000 loan at a 6% interest rate with 1 point and $6,000 in fees, or a $150,000 loan with 6.25% interest, no points and $2500 in fees. Although the first offer has a lower interest rate, it could very well be less expensive than the second offer depending on the individual APRs.

However, this metric does assume that the borrower keeps the mortgage for the full term. If in fact this is not the case and the house is sold or refinanced, these fees are no longer spread over the full term (say 30 years) and so the interest rate is higher than would be calculated. Since this is a somewhat rough approximation, I recommend that you plug in all the parameters into a mortgage calculator, especially if you only plan on keeping the mortgage for 7-10 years versus the full 30 year term.