Is the lowest interest rate always better?
I get asked what is the difference between the interest rate and APR all the time but recently I was
working with a client who was hesitating to work with me because another lender had quoted them an
interest rate lower than mine. So low I didn’t believe it to be a real interest rate and asked the client to
get an interest rate and closing cost breakdown from the other lender.
When I received the breakdown, it was a real interest rate alright, but they were charging 1 origination
point and 2 discount points for a total of 3 points to buy down the rate. The loan amount was slightly
over $300,000 so this equaled over $9,000.
I reviewed this with the client and pointed out that although their interest rate was substantially lower
their APR was substantially higher and that my quote with the higher interest rate was actually the lower
cost to borrow money.
So what is an APR and why should you care?
The APR is a number that discloses the true cost of borrowing money over the life of the loan. It is a
shopping tool that discloses the loan fees and interest rate in one number making it easy to compare
options from different lenders. Basically, you take all of the closing costs or finance charges and divide them by the term of the loan and add it onto the interest rate.
For example, if you are going to take out a 60-month auto loan for $10,000 and lender 1 offers you a rate
of 6% and no fees and lender 2 offers you a rate of 4% with $500 in fees. Which choice is better? Is it
lender 2 with the 4% rate? It is kind of hard to tell right?
Lender 1’s APR is 6% (remember a 6% rate with no fees equals a apr of 6%)
Lender 2’s APR is 6.113%. The rate is 4% but with that $500 in fees this loan is actually more expensive
than lender 1’s.
The point is, when it comes to borrowing money, its not always about the lowest interest rate which can
be deceiving. The real number you should be looking at is the APR.
If you have any questions about an APR with anything, a credit card, an auto loan or a mortgage. Call us today and we would love to help you and answer any questions you may have.
