A textbook definition of Annual Percentage Rate, APR, is as follows. Charges imposed on a borrower to obtain a mortgage, expressed on an annualized basis as an interest rate. The APR includes the annual interest rate (AIR), loan fees and points. In the USA the APR is meant to disclose the total cost of borrowing. In Canada the APR is defined in section 6 of the Federal Interest Act in an ambiguous manner and is generally understood to mean effective interest rate (EIR). In Canada, Ontario specifically, the total cost of borrowing, TCOB is calculated as the new EIR because of loan fees and points.
Here is an American APR example (taken from a printed booklet) showing
why you should be very careful acting upon "rules of thumb".
Which is better? Loan#1, a $100,000, 30 year
In loan #1, the APR is nothing more than
the new annual interest rate of 10.3657% because of the $3000 (3 points
is 3% of $100,000 = $3000). Changing the Principal to $97,000 and recalculating
the annual interest rate gave a new rate of 10.3657%. The borrower is
making monthly payments based on $100,000 even though the net amount left
is $97,000 thus the rate in reality is 10.3657%. Because of the up front
In loan #2, the APR is nothing more than
the new annual interest rate of 10.3716% because of the $1000 (1 points
is 1% of $100,000 = $1000). Loan#2 is the more expensive loan (because
of the APR method) because the APR is 10.3716% which is greater than 10.3657%.
So much for the books
When the APR is meaningless!
If the loan or mortgage is an exact day monthly payment based upon a 365 day year or an exact day monthly payment based upon a 360 day year, ..the APR is not accurate. The algebraic formulas cannot take into account the changing monthly interest factor. Consider a $300,000 mortgage at 6% for 30 years. Taking into account total fees of $3,000, the lender that uses a 365 day year monthly schedule will collect $1,144 more in interest over the 30 years (comparing spreadsheet interest), yet both lenders would quote you an APR of 6.094%. This screenshot demonstrates the point.
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