Scenario: I've just started shopping for a loan in order to buy our first home. We would like to pay 10-15% down payment as our combined income is decent enough. But I'm confused over the loan options, more so, when it comes to deciding between the rates and the fees. I mean what do I do and why if I am offered 2 fixed rate loans (20 year loan term) of the same amount $100,000 at 5.5% and 6.15% rates of interest respectively, their APRs being 6.125% and 6.45%. I've received a good faith estimate on the loans; for the first they say, I'll have to pay $3000 while for the second one I would require paying just $1000. How do I decide between the two? Should I go with the one having low APR?

Situation: Lenders determine the APR on loan offers as they intend to include the loan costs along with the principal loan amount. The APR serves as a purpose to compare between a loan with a high rate and low fees and low rate and higher fees. But there are some downsides.

The APR assumes zero inflation and that the value of money would remain unchanged in years to follow. Next, lenders assume that the loan will never be refinanced, prepaid or sold off. So, there are a number of aspects which aren't considered while lenders for your loan offer.

The most important factor that lenders include while calculating the APR, is the amount financed, which is equal to the mortgage loan amount minus any lender fees, points, commitment fees and interim interest. So, the higher the fees, the lower will be the amount financed. And, the monthly payment is based on the amount financed.

Now, let's put the details of the loan offers you've spoken about.

Mortgage amount = $100,000

Interest rate = 5.5%

APR = 6.125%

Fees = $4000

So, the Amount Financed = $(100,000 ? 4000)= $96000

Using the FRM Calculator, monthly payment = $687.89

For Loan B:

Mortgage Amount = $100000

Interest Rate = 6.15%

APR = 6.45%

Fees = $800

So, the amount financed = $(100,000 ? 800)= $99200

Using the FRM calculator, monthly loan payments = $725.11

The difference between monthly payments on Loan A and Loan B = $(725.11 ? 687.89)= $37.22

Now, Loan A having a low APR and monthly payment looks to be a better deal compared to Loan B. But it isn't so. This is because Loan A requires you to pay $4000 in fees unlike Loan B which has high APR but gives you the chance to save $3200 in loan fees.

Moreover, just to save $37 (approx.) in monthly payment, if you pay fees as high as $3200 in excess, it isn't a wise decision. So, going for Loan A doesn't seem to be the right option here. But if you are choosing loan B, then why not borrow $3200 less as you're saving it in loan fees. So, the amount for Loan B comes out to be $98000 ($100,000 - $3200 = $96800).

With the new amount, monthly payment on Loan B = $701.91

Comparing this with payment on Loan A, the difference = $(701.91 - 687.89)= $14.02

This shows that it's worth taking Loan B with an amount less than that of A, the difference being your savings in loan fees. Therefore, a loan with a high APR and low fees can be a better option compared to one which has low APR and higher fees. So, APR isn't the right factor to compare loans; it is deceptive and can be manipulated too.

If you have any query on APR or wish to discuss further on this, feel free to ask questions and get suggestions from the community through our .