What is APR (ÅOP), and what does it tell you about a mortgage?

ÅOP stands for ‘årlige omkostninger i procent’ (annual costs as a percentage), the Danish equivalent of the annual percentage rate (APR). The Danish Credit Agreements Act (kreditaftaleloven) defines it as the total cost of the credit agreement, expressed as an annual percentage of the total amount of credit. When you see an APR figure on a loan offer, it is not an estimate. It is the result of a fixed calculation method.

You will find that method in section 16 of the Credit Agreements Act and, for loans secured on real property, in section 16 a. The Act was passed in 1990 and came into force in 1991, replacing the Credit Purchase Act (kreditkøbsloven) that applied at the time. The calculation itself is set out in Annex 1 to the Act and, for home loans, in Annex 4, where a basic equation sets the present value of the credit drawn down equal to the present value of your repayments and costs. The APR is the annual interest rate that makes the two sides of the equation balance, in other words the internal rate of return of the loan’s payment stream.

That is why the APR is always greater than or equal to the borrowing rate (debitorrente). The borrowing rate contains nothing but the interest used to amortise the loan, whereas the APR also includes the other costs you pay in connection with the agreement.

The Credit Agreements Act regulates credit agreements between lenders and consumers in Denmark, and the APR must be stated so that you can compare different offers on a like-for-like basis. The APR is a useful benchmark, but it does not tell the whole story of what a loan will actually cost you if, for example, you pay it off early.

What is included in the APR

The APR brings a loan’s costs together in a single figure, so you can compare the price across offers without adding it all up yourself. What is included in the APR therefore matters a great deal for how comparable the figure is.

These are some of the types of cost combined in the figure:

• Contribution fees (bidrag), which you pay on an ongoing basis to the mortgage credit institution if you have a mortgage loan.

• Arrangement fees (stiftelsesprovision), meaning the costs tied to setting up the loan itself.

• Ongoing fees paid over the life of the loan.

They are included in the APR but not in the borrowing rate. The borrowing rate only covers the interest used for amortisation, so the other items are precisely what lifts the APR above the borrowing rate.

The law defines costs broadly. Every cost the lender knows about must be counted, including interest, commission, taxes and fees. The cost of insurance, for example, also counts if the insurance is a requirement for getting the loan or for getting it on the advertised terms. Fees for an account linked to the loan must be included if the account is compulsory.

What is not necessarily included in the APR

The calculation method assumes that the loan runs for the full agreed term. That assumption is built into the method, and if you pay the loan off early, the actual costs may differ from the APR. With a home loan, it is rare for the loan to run its full term. Most people sell, refinance or make extra repayments along the way. Once the assumption no longer holds, the APR no longer describes your situation. You have the right to repay early with a reduction in costs. But it is not the APR that shows you what that reduction will actually be.

There are also items that are not in the figure. The land registration fee (tinglysningsafgift) for the deed is not included in the APR, whereas the fee for registering the mortgage deed for the loan normally is. The costs of refinancing the loan later are not included either, and the same goes for late-payment interest and reminder fees if you pay late. These are amounts you may end up paying without them ever having been part of the figure you compared.

The APR is also a figure based on the assumptions that apply at the time of the offer. If the interest rate, fees or loan terms change later, the total costs change, while the original APR remains as a historical snapshot.

The difference between the APR and the total repayment therefore matters when you weigh two offers against each other. The APR does not include all the amounts you may actually end up paying if you repay early or refinance.

Why two loans with the same APR are not the same

When you compare loan offers, it is natural to start with the APR, because the figure is designed for exactly that purpose. You should use the APR to compare loans of the same kind. The loan type, term, redemption terms and tax treatment should be the same before the comparison gives you a fair basis. If you compare a loan with one set of terms against a loan with another, you are not measuring the same thing.

Even when the framework is the same, two loans can have the same APR and still work out differently in practice. The payment profiles can be structured differently, so one agreement takes more money out of your pocket early on and the other later. Fees can fall at different points in the life of the loan, and the bond price when the loan is taken out can differ. The price loss is included in the APR, but it affects how much outstanding debt you are left with if you sell or pay off the loan early.

The APR therefore does not always give an accurate picture and cannot be used in every situation. Among other things, the comparison assumes that the loans have the same loan amount and the same term. Change just one of those factors, and the figures are no longer directly comparable.

This is where the difference between the APR and the effective interest rate matters in practice. The APR combines the interest and the loan’s other costs into one annual percentage, whereas the effective interest rate is an annual rate that does not include all the costs. So the two figures do not tell you the same thing, and neither of them can stand alone as the answer to what a loan costs.

Bond price and price loss

The bond price (kurs) is the price of the bond behind a bond loan. It is stated relative to the bond’s face value. When a loan is taken out at a price of 100, the price equals the face value and there is no price loss. A price loss (kurstab), on the other hand, arises when the bond is issued at a price below 100. This happens when the market prices the bond lower than its face value.

The price loss is the difference between the outstanding bond debt and the loan amount paid out. In other words, you pay interest and repayments on a higher outstanding debt than the sum you actually received, and that difference is precisely what the price loss is. It directly affects how much money you actually receive once the loan has been set up.

The price loss is included in the APR, but it can still make two loans with the same APR different in practice. If one offer has a bigger price loss when the loan is taken out than the other, you start with a higher outstanding debt relative to the amount that landed in your account. You will feel the difference if you sell your home or pay off the loan early.

When comparing, you should therefore look at both the APR and the price loss. The price loss does not always show clearly in an APR comparison alone, and two offers can look the same on paper even though the amount paid out differs.

Checklist for comparing two loan offers

Here is a checklist you can go through before you decide anything at all.

• Check that both offers state the same loan amount, the same term and the same type of loan. If even one of those differs, the APR comparison will not give a fair picture.

• Ask for a statement of the total repayment and the credit costs as amounts in kroner, not just as an APR. The percentage is useful for getting an overview, but it is the amounts that show what you pay.

• Compare the fees, commissions and other costs included in the APR, and note which are paid upfront when the loan is taken out and which are paid on an ongoing basis over the life of the loan.

• Find out whether the offer includes information on costs that are not in the APR, such as the land registration fee for the deed or the costs of refinancing the loan later.

So when you compare two loan offers, it is not enough to hold the two APR figures up against each other. You also need a clear view of the amounts behind the figure and of the items that fall outside the calculation.

The checklist only works if the two offers are still comparable. If the terms change along the way, you have to start again.

A worked example with made-up figures

A worked example can help show what the APR means in practice. The figures below are made up and are used only to illustrate the point, not to reflect current rates. The total repayment is calculated for an annuity loan with monthly payments, with all costs included in the APR.

Offer A has the lower APR but the higher total repayment. The difference of approx. 80.000 kr. comes from Offer A running five years longer than Offer B. Even though the annual cost as a percentage is lower, you pay more in total, because there are more years of interest on top. That is why the term must be the same when you compare APRs. If you compare a 30-year loan with a 25-year loan, the two APR figures are not built on the same basis, and the lower figure does not automatically give you the lower total cost.

The example shows that the APR alone does not tell you what you will pay in total.

What to ask the bank for

You get the most accurate comparison when you ask for the full documentation instead of just looking at the APR figure at the top of the offer.

• Ask for the European Standardised Information Sheet (ESIS). It is Annex 5 to the Credit Agreements Act and must be given to you on paper or another durable medium, so you have the information to hand.

• The ESIS is not an optional form. When the loan is secured on real property, the bank or mortgage credit institution must use the ESIS under section 7 a of the Credit Agreements Act. You must receive the form once you have provided the necessary information about your finances and your wishes.

• Also ask for information on the total repayment, the credit costs as amounts and the nominal borrowing rate, not just the APR. It is the amounts in kroner that show what the loan costs you over time.

• Ask about the redemption terms so you know what it costs to pay off the loan early. The APR does not show that.

The bottom line is that the APR is one figure based on certain specific assumptions. It assumes that the loan runs for its full term, and it does not necessarily include all the amounts you may actually end up paying. You can only compare two offers fairly once the loan amount, term and conditions are the same, and once you have the total amounts in front of you, not just the APR. So start by asking the bank for the paperwork.