The effective annual rate of return taking into account the effect of compounding interest. APY is calculated by:
= (1 + periodic rate) to the power of # of periods - 1
The resultant percentage number assumes that funds will remain in the investment vehicle for a full 365 days.
The APY is similar in nature to the annual percentage rate. Its usefulness lies in its ability to standardize varying interest-rate agreements into an annualized percentage number.
For example, suppose you are considering whether to invest in a one-year zero-coupon bond that pays 6% upon maturity or a high-yield money market account that pays 0.5% per month with monthly compounding.
At first glance, the yields appear equal because 12 months multiplied by 0.5% equals 6%. However, when the effects of compounding are included by calculating the APY, we find that the second investment actually yields 6.17%, as 1.005^12-1 = 0.0617.
Friday, March 7, 2008
What is an Annual Percentage Rate (APR)?
The annual percentage rate (APR) is an interest rate that is different from the note rate. It is commonly used to compare loan programs from different lenders. The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. Typically the APR is found next to the rate.
Example: 30-year fixed 8% 1 point 8.107% APR
The APR does NOT affect your monthly payments. Your monthly payments are a function of the interest rate and the length of the loan.
The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the "true cost of a loan." It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.
If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan. Right? Wrong!
Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. The best way to compare loans in the author's opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.
The reason why APRs are confusing is because the rules to compute APR are not clearly defined.
What fees are included in the APR?
The following fees ARE generally included in the APR:
Points - both discount points and origination points
Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
Loan-processing fee
Underwriting fee
Document-preparation fee
Private mortgage-insurance
The following fees are SOMETIMES included in the APR:
Loan-application fee
Credit life insurance (insurance that pays off the mortgage in the event of a
borrowers death)
The following fees are normally NOT included in the APR:
Title or abstract fee
Escrow fee
Attorney fee
Notary fee
Document preparation (charged by the closing agent)
Home-inspection fees
Recording fee
Transfer taxes
Credit report
Appraisal fee
An APR does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock may have a lower APR than a lender who offers you a 60-day rate lock!
Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs. A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.
Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!
Conclusion :
Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.
Example: 30-year fixed 8% 1 point 8.107% APR
The APR does NOT affect your monthly payments. Your monthly payments are a function of the interest rate and the length of the loan.
The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the "true cost of a loan." It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.
If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan. Right? Wrong!
Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. The best way to compare loans in the author's opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.
The reason why APRs are confusing is because the rules to compute APR are not clearly defined.
What fees are included in the APR?
The following fees ARE generally included in the APR:
Points - both discount points and origination points
Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
Loan-processing fee
Underwriting fee
Document-preparation fee
Private mortgage-insurance
The following fees are SOMETIMES included in the APR:
Loan-application fee
Credit life insurance (insurance that pays off the mortgage in the event of a
borrowers death)
The following fees are normally NOT included in the APR:
Title or abstract fee
Escrow fee
Attorney fee
Notary fee
Document preparation (charged by the closing agent)
Home-inspection fees
Recording fee
Transfer taxes
Credit report
Appraisal fee
An APR does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock may have a lower APR than a lender who offers you a 60-day rate lock!
Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs. A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.
Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!
Conclusion :
Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.
Oil Gyrates, but Hits New Record
AP
Friday March 7, 12:10 pm ET
By John Wilen, AP Business Writer
Oil Prices Fluctuate but Hit New Record Above $106 on Interest Rate, Dollar Expectations
NEW YORK (AP) -- Oil prices jumped to a new record above $106 Friday but extended their recent pattern of choppy trading after a weak jobs report convinced many traders that the Federal Reserve's interest rate-cutting campaign will continue.
Employers cut 63,000 jobs in February, the biggest drop in five years, the Labor Department said Friday. Investors can react to such news in one of two ways: by selling on the prospect that the economy, and demand for oil, is cooling, or by buying on a conviction that bad economic data makes it more likely the Fed will cut rates.
On Friday, investors engaged in a little of both, sending oil prices down more than a dollar at one moment, and propelling them to new records the next.
"The higher the market goes, the more volatile it becomes," said Darin Newsom, senior analyst at DTN in Omaha, Neb. "Does it mean that the rally is over? No."
Light, sweet crude for April delivery rose 46 cents to $105.93 a barrel on the New York Mercantile Exchange after setting a new trading record of $106.54.
At the pump, meanwhile, gas prices extended their march toward new records, rising 0.4 cent to a national average of $3.189 a gallon, according to AAA and the Oil Price Information Service. Gas prices are 68 cents higher than a year ago, and within a nickel of last May's record price of $3.227 a gallon. Many analysts expect prices to jump much higher as driving demand picks up in the spring.
Lower interest rates tend to weaken the dollar, and many analysts believe the weak dollar is the reason why oil has set new inflation-adjusted records three times this week, and risen 23 percent in less than a month.
Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is falling. On Friday, the dollar set a new low against the euro Friday before rising. But most investors believe that despite occasional rebounds, the dollar is likely to continue falling as the Fed continues to cut rates.
"The swings in the dollar are still the most critical item," said Jim Ritterbusch, president of Ritterbusch and Associates, an energy consultancy in Galena, Ill.
Concerns about a possible conflict between oil producers Venezuela and Colombia also supported oil prices Friday. Earlier this week, rebels attacked and shut down a a Colombian oil pipeline that transports 60,000 barrels of oil a day in retaliation for a Colombian raid into Ecuador. Venezuela threatened to slash trade and nationalize Colombian-owned businesses, and Venezuela and Ecuador have sent troops to their borders with Colombia.
Many analysts believe oil is overvalued, arguing that oil supplies are at high levels and the demand is falling. In its latest inventory report, the Energy Department said overall demand for oil dropped 3.4 percent over the last four weeks compared to the same period last year.
"We don't see oil demand accelerating while the price has its foot on the throat of consumers," said Tim Evans, an analyst at Citigroup Inc., in a research note.
But while analysts expect oil's underlying supply and demand fundamentals to eventually pull down its price, few are willing to predict when that will happen. Meanwhile, oil could continue rising to as high as $120 in the short term, according to some forecasts.
Goldman Sachs, a widely watched oil price prognosticator, said oil could average $110 a barrel by 2010, up from a previous forecast of $80, and said a price spike as high as $200 a barrel is possible, according to Dow Jones Newswires.
Other energy futures were mixed Friday. April gasoline futures rose 3.26 cents to $2.6858 a gallon, while April heating oil futures fell 0.38 cents to $2.9695 a gallon. April natural gas futures rose 15.8 cents to $9.90 per 1,000 cubic feet.
In London, April Brent crude rose 66 cents to $103.27 a barrel on the ICE Futures exchange.
Associated Press writers Pablo Gorondi in Budapest and Gillian Wong in Singapore contributed to this report.
Friday March 7, 12:10 pm ET
By John Wilen, AP Business Writer
Oil Prices Fluctuate but Hit New Record Above $106 on Interest Rate, Dollar Expectations
NEW YORK (AP) -- Oil prices jumped to a new record above $106 Friday but extended their recent pattern of choppy trading after a weak jobs report convinced many traders that the Federal Reserve's interest rate-cutting campaign will continue.
Employers cut 63,000 jobs in February, the biggest drop in five years, the Labor Department said Friday. Investors can react to such news in one of two ways: by selling on the prospect that the economy, and demand for oil, is cooling, or by buying on a conviction that bad economic data makes it more likely the Fed will cut rates.
On Friday, investors engaged in a little of both, sending oil prices down more than a dollar at one moment, and propelling them to new records the next.
"The higher the market goes, the more volatile it becomes," said Darin Newsom, senior analyst at DTN in Omaha, Neb. "Does it mean that the rally is over? No."
Light, sweet crude for April delivery rose 46 cents to $105.93 a barrel on the New York Mercantile Exchange after setting a new trading record of $106.54.
At the pump, meanwhile, gas prices extended their march toward new records, rising 0.4 cent to a national average of $3.189 a gallon, according to AAA and the Oil Price Information Service. Gas prices are 68 cents higher than a year ago, and within a nickel of last May's record price of $3.227 a gallon. Many analysts expect prices to jump much higher as driving demand picks up in the spring.
Lower interest rates tend to weaken the dollar, and many analysts believe the weak dollar is the reason why oil has set new inflation-adjusted records three times this week, and risen 23 percent in less than a month.
Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is falling. On Friday, the dollar set a new low against the euro Friday before rising. But most investors believe that despite occasional rebounds, the dollar is likely to continue falling as the Fed continues to cut rates.
"The swings in the dollar are still the most critical item," said Jim Ritterbusch, president of Ritterbusch and Associates, an energy consultancy in Galena, Ill.
Concerns about a possible conflict between oil producers Venezuela and Colombia also supported oil prices Friday. Earlier this week, rebels attacked and shut down a a Colombian oil pipeline that transports 60,000 barrels of oil a day in retaliation for a Colombian raid into Ecuador. Venezuela threatened to slash trade and nationalize Colombian-owned businesses, and Venezuela and Ecuador have sent troops to their borders with Colombia.
Many analysts believe oil is overvalued, arguing that oil supplies are at high levels and the demand is falling. In its latest inventory report, the Energy Department said overall demand for oil dropped 3.4 percent over the last four weeks compared to the same period last year.
"We don't see oil demand accelerating while the price has its foot on the throat of consumers," said Tim Evans, an analyst at Citigroup Inc., in a research note.
But while analysts expect oil's underlying supply and demand fundamentals to eventually pull down its price, few are willing to predict when that will happen. Meanwhile, oil could continue rising to as high as $120 in the short term, according to some forecasts.
Goldman Sachs, a widely watched oil price prognosticator, said oil could average $110 a barrel by 2010, up from a previous forecast of $80, and said a price spike as high as $200 a barrel is possible, according to Dow Jones Newswires.
Other energy futures were mixed Friday. April gasoline futures rose 3.26 cents to $2.6858 a gallon, while April heating oil futures fell 0.38 cents to $2.9695 a gallon. April natural gas futures rose 15.8 cents to $9.90 per 1,000 cubic feet.
In London, April Brent crude rose 66 cents to $103.27 a barrel on the ICE Futures exchange.
Associated Press writers Pablo Gorondi in Budapest and Gillian Wong in Singapore contributed to this report.
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