Annual percentage rate

From ArticleWorld

Annual Percentage Rate, APR, is an expression of the effective interest rate which shall be paid on a loan. Taking into account one-time fees and standardizing the way this rate is designed. The APR is likely to differ from the "note rate" as advertised by the lender. The aim of using APR is to calculate a total cost of borrowing which allows a relatively simple comparison between loans and lenders.

While there are several acceptable ways to calculate the exact APR, the general process typically is:

1. Total the included one-time costs and add them to the base amount on the overall loan
2. Calculate and determine a monthly payment for that amount at the loan's "note rate"
3. Calculate what interest rate would have to be applied to just the base amount of the loan in order to equal the calculated monthly payment in step 2.

APR's failings

Despite repeated attempts by regulators to establish usable and consistent standards, APR does not represent the total cost of borrowing nor can it truly create a comparable standard. Regardless, it is considered a reasonable starting point for a comparison of available lenders.

APR cannot represent the total cost of borrowing

Some types of fees are deliberately not included in the base calculation. Because these fees are not added, some consumer claim that the APR does not represent the complete cost of borrowing. Excluded fees might include the following:

Excluded fees

routine one-time fees which are paid to an outside source, or penalties such as late fees or service reinstatement fees without regard for the size of the penalty or the likelihood that it will be imposed.

Lenders argue that the real estate attorney's fee is an example of a pass-through cost, not a cost of the lending. Basically, they are arguing that the attorney's fee is a separate transaction and not a cost of the actual lending. This is true if the attorney’s fees are the same base cost everywhere, or if the customer is free to select which attorney with is used.

If the lender insists on using a specific attorney however, then the cost should be looked at as a component of the total cost of doing business with that lender. This area is made even more complicated due to the practice of the lender receiving money from the attorney and other agents to be the one used specifically by the lender.

Because of this, the government has made all lenders produce an affiliated business disclosure form, which shows the amount paid by the lender to things like appraisal firms and attorneys.

Lenders argue that including late fees and other conditional charges would require them to make assumptions about the consumer's behavior. assumptions which would creates bias that would result in a calculation that would create even more confusion than clarity.