What exactly is an APR?

/ Source: msnbc.com

Q: When comparing mortgages, what would be the best definition of what the annual percentage rate signifies? In other words, if I have an APR of 6.1 percent, would that be better than a mortgage of 5.9 percent? — John B.

A: The annual percentage rate is designed to help you get an apples to apples comparison of the true cost of a mortgage. But you still need to compare the terms carefully: if you prefer Macintosh to Red Delicious, then that’s the best apple for you.

The “nominal rate” is the basic interest rate charged on the money you borrow (the principal). The “annual percentage rate” — or APR — factors in some of the upfront costs that vary from one loan to another (like points, fees and mortgage insurance) and spreads them over the life of the loan. (Other fees — like document preparation and application fees, title insurance, or appraisals — aren’t included.)

In theory, you’ll pay the same amount for two loans with the same APR — if you stick with that loan for the full 15-year or 30-year term. But few people do; most either refinance their mortgage or sell their house and move on long before their original mortgage is paid off. If you plan to move in a few years, you may want the loan with the lowest upfront costs, regardless of the APR.

Unfortunately, the only way to really compare is to do the math: if you plan to move in 5 years, for example, spread your upfront costs over 60 monthly payments and see which deal is better.