What Is APR on a Mortgage?

APR stands for the Annual Percentage Rate of interest on a mortgage or loan. It typically has two definitions, nominal and effective APR, and is used as a finance charge, returning money to the lender above and beyond the principal loaned.

Amortization Schedule

APR is typically applied as compound interest across the year, meaning that the debt grows as interest owed is added to the principal. The long terms of mortgage notes, typically 30 years, result from payments being applied to interest, while impacting the principal little, at least at the beginning of the term. These payment plans are known as amortization schedules and are a direct result of the APR applied to the principal. The money paid back over the term is often more than double the money originally borrowed, often as much as 300 percent.

APR can be Confusing

APR can be confusing for people not familiar with the mathematics of finance. As a result, banks often use APR to package loans in different ways, to look more attractive, when, in reality, they mean the same thing. For example, an APR of 5 percent is the same as 0.00407412 percent monthly compound interest (or 1.05 ^(1/12)).

Effective APR Versus Nominal APR

Compounding interest has a huge impact on interest paid. Depending on the compounding interval, a seemingly small interest rate may, in fact, grow the debt faster as a result of applying the interest to the debt more times over an agreed upon term. Credit cards typically compound interest monthly but list APR from an annual perspective. To understand this difference, consider the relationship between nominal APR and effective APR:
Effective APR = ((1 + nominal APR/n)^n)-1
Where n is the number of compounding periods. An APR advertised as 9 percent by a credit card company, but compounded monthly, equals an effective APR of 9.38069 percent. This small difference, due to the compounding of interest, makes a large difference over the length of the debt. In fact, the longer the debt is maintained, the greater this difference becomes.

APR Applied to Other Fees

Often, a loan or mortgage applies APR to other fees associated with closing costs, such as loan origination fees, insurance, processing fees and so forth. This increases the cost of borrowing more than you might think at first glance. Make sure you read and understand what it is you are committing to.

Ask Questions!

Never be afraid of asking questions. This stuff is complicated (often deliberately so), so make sure you understand what it is you're committing to. Don't be embarrassed to ask what something means or to request a complete amortization schedule showing the total amount you have paid back by the end of the term. Ask them to include all other fees to which interest may be applied to. You want to be clear; after all, you'll be paying back a lot more money than you borrowed, and for a long time.