Why APRs, Interest Rates and Origination Fees are Important

What’s an APR and Interest Rate?

Both an APR and interest rate are quotes for the annual percentage you will pay back for the amount you ultimately borrow. The main difference between the two is that APR’s include all associated finance costs and points and are more reflective of the “real” annual cost of borrowing on the debt issued. Essentially, APRs are inclusive of everything while interest rates aren’t.

What Do APRs Include?

Depending on the financial product, APR’s will tend to include origination fees, application fees, points, PMI and other finance related fees. This inclusion can make a big difference and can be very significant in terms of the total amount paid back. It can equate to thousands of dollars in savings and fees in the long run.

Origination Fees

The origination fee is essentially the fee for acquiring the loan. It’s typically charged by the lender that is issuing you the loan or helped you acquire it. These fees range in size but they can go from hundreds up to thousands of dollars depending on the parameters of the loan. In a lot of ways, origination fees are a sort of upfront interest payment. They are large enough to have a serious impact on your payback and are known for eating into the principal amount of your loan amount.

A Lower Interest Rate Isn’t Always the Cheapest Option

Given our three variables and how they interact with each other, the lowest interest rate option is not always the cheapest option in the market. Technically speaking, the lowest APR should be the best offering and it helps if you compare financial products in an apples to apples comparison. If you don’t, you won’t really know which offering is the best, since comparing an APR with an interest rate can lead to misjudgment.

For example. You apply for a personal loan with two different lenders. Lender One advertises an interest rate of 7% and Lender Two advertises an interest rate of 7.25%. Lender one however has a $1,000 origination fee and is offering you no points. Lender two on the other hand has a $200 origination fee and is offering 2 points. In this scenario, over the amortization of the personal loan, you actually pay less for borrowing from Lender two, even though they are offering a lower interest rate.

The best way to decide is on which is right for you is by making note of the amortization over the entire payback of the loan. Moreover, will you be pre-paying and will you be taking advantage of points of the long term? These factors will also matter but if you plan on paying down your loan as is stated in the terms of the agreement looking at the APR will be most beneficial.