Definition
Annual Percentage Rate (APR) is the yearly cost of borrowing money expressed as a percentage, including interest plus any fees or additional costs associated with the loan. APR provides a more complete picture of borrowing costs than the nominal interest rate alone by factoring in origination fees, closing costs, mortgage insurance, and other charges. Lenders are required to disclose APR to help consumers compare loan offers more accurately.
Formula
Where Interest is total interest paid, Fees are additional loan costs, Principal is the loan amount, and n is the loan term in days. Actual APR calculations are more complex and consider the timing of payments.
Example
Mortgage APR Example
A lender offers a $200,000 mortgage with a 6% interest rate. With $5,000 in closing costs and origination fees, the APR might be 6.25%. This higher rate reflects the true cost of borrowing. Loan A with 5.5% interest but $8,000 in fees might have a higher APR than Loan B with 5.75% interest but only $2,000 in fees, making Loan B the better choice despite its higher nominal rate.