What is "APR"?

Annual percentage rate, or APR for short, is a numerical expression of the cost of extending credit. APR is the amount a borrower must pay every year for the privilege of getting a loan or other credit- the law requires that lenders disclose the APR to their consumers. This law is called the Truth in Lending Act; originally ratified in 1968, it was a part of the CPA (Consumer Protection Act). In 1980, the TLA was reformed and made part of the Depository Institutions Deregulation and Monetary Control Act.

The APR's purpose is to let consumers compare different loan products and determine which suits their financial needs best. It serves to make it harder for lenders to use deceptive fee practices- the APR allows for a level playing field in the loan market and it helps borrowers make more financially sound decisions. While the APR can be used to compare loans, the number can also be confusing. Every lender's calculations are different, meaning a lower-APR loan may not be cheaper than one with a higher annual percentage rate.

Lenders do have some leeway when figuring the APR. Without flouting the law, they can undercut the APR by one-eighth of a percentage point- for "irregular" loans, the lender may legally undercut the APR by one-quarter of a percentage point. To make the process even more murky, there are fees included in the annual percentage rate. These can vary depending on the loan- prepaid interest, points, PMI (private mortgage insurance) and processing and underwriting fees are usually included in the APR.

To avoid any discrepancy when comparing loans, some experts suggest that borrowers calculate the APR themselves. This can be done by getting a good-faith estimate from lenders offering comparable loan products. After this is done, subtract all fees (these are to be added separately). The loan with the lowest fees is the one the borrower should choose, but this method only works on loans that have identical interest rates.