What Does A Loan Really Cost?

by Peter G. Miller
September 11th, 2007

It is natural and reasonable to want to know how much a loan costs, whether FHA or not. Savvy borrowers know that the interest rate is not the full cost of the loan — there’s a difference between a loan at 6.75 percent at 6.6 percent plus 2 points — the “higher” rate may actually be the cheaper loan.

You might think, aha, what about the “annual percentage rate” or APR? Surely that’s a trustworthy measure of a loan’s true cost. Right?

Er, well, not really.

A Minnesota lender, First Equity Mortgage, has posted an usually clear explanation of the APR — and why it’s not an absolute measure of a loan’s cost. Says First Equity:

“The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the ‘true cost of a loan.’ It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.

“If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan. Right? Wrong!

“Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. The best way to compare loans in the author’s opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.”

There’s more on the page, it’s probably the best explanation of the APR I have found online. For more, go to:


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This entry was posted on Tuesday, September 11th, 2007 at 3:36 am and is filed under , . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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