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When looking at mortgages they all have an APR figure "for comparison". What does APR mean, and how does it allow you to compare the products?

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Dheer's explanation is pretty good in the general case for a nominal APR, but the APR figure quoted for a mortgage in the US has a slightly different meaning as specified by the Truth In Lending Act.

The APR for a mortgage includes both the base interest rate for the mortgage, but also accounts for certain fees and any points (pre-paid interest) included. This allows you to make an apples-to-apples comparison between mortgage quotes.

For example, you might see a mortgage quote for 3.85% and another for 4.125%. Obviously the 3.85% looks better on the surface, but it might require you to pay an extra $2,000 up front in pre-paid points to get that rate, while the 4.125% mortgage does not require any up-front points to be paid. Now it's not quite so clear which one is the better deal.

If you were to look at the APR for those two quotes though, the $2,000 fee on the first mortgage would be taken into account and amortized over the life of the mortgage, giving you a more accurate picture of the real cost.

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APR is Annual Percentage Rate and there are accepted rules as to how this should be calulcated.
For more details see http://en.wikipedia.org/wiki/Annual_percentage_rate

The key idea of regulators making it mandetory to quote APR is it becomes easy to compare the actual rate of interest being charged.

For example one lender may quote a Rate as 2% per month, interest accrued every month and the other may quote 24% on yearly basis.

An effective annual interest rate of 10% can also be expressed in several ways:
0.7974% effective monthly interest rate, because 1.007974^12=1.1
9.569% annual interest rate compounded monthly, because 12*0.7974=9.569
9.091% annual rate in advance, because 1/1.1=1-0.091

Thus to an not avid end user, it becomes more easier to compare the rate of interest.
It also does not allow financial institutions to charge more by resoting to some juglarry, ie saying that rate of interest is less, and you have to pay 3 EMI's(Equated Monthly Installments) in advance etc.

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  • 2
    Sorry - what does EMI stand for? – Bluebelle Oct 22 '10 at 11:20
  • Also - does the APR provide a sensible comparison for when a mortgage lists (for example) the starting interest rate for say two years as 2%, and then 4% variable rate afterwards - versus one that has a starting at 2.5% for 5 years and then rising to a 3% variable rate afterwards? (These are just arbitrary numbers, not actual products I have found!) Thanks for your help. – Bluebelle Oct 22 '10 at 11:23
  • Variable rates are a whole new bag of worms. The APR is only good for the 1-7 years contracted. After that point the rate follows an interest rate index (like LIBOR as calculated and published by news agency(ies)) plus an APR percentage premium on top of .2-2%. There is almost NO reason to get a variable rate loan when interest rates are at a rock bottom, since the variable rate can only go up. – SpecKK Oct 22 '10 at 16:33

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