A formula for the after‐tax APR for home mortgages

Abstract

PurposeThe purpose of this paper is to provide a simple formula for determining a borrower's APR for mortgage loans after including the effects of mortgage interest tax deductions.Design/methodology/approachThis formula is derived by adjusting the APR provided by the lender for the length of the mortgage, the amount of discount points, the mortgage interest rate, and the borrower's tax rate.FindingsFrom this formula, it is found that the tax‐adjusted APR is not only lower but also more informative than the traditional APR.Research limitations/implicationsThe tax‐deductible items of a mortgage loan used in this formula for after‐tax APR are based on those stipulated under US tax law. However, this formula can easily be adapted to other internal rate of return methods such as the annual effective rate of return (AER). In addition, further research is needed to develop a formula when a mortgage loan is the result of a refinance. Under this situation, mortgage discount points are no longer tax‐deductible in the year of their occurrence. Rather, the deduction of points must be amortized over the life of the loan.Practical implicationsThe tax‐adjusted APR formula developed in this paper is tailored to each mortgage applicant by providing a more realistic assessment of the applicant's true cost of borrowing.Originality/valueEven though it is known that the after‐tax APR decreases as an individual's marginal tax rate increases, no explicit formula existed for determining the after‐tax APR. This is the first such formula. Thus, this formula will help the consumers in the mortgage market to be more informed in their decision‐making process.

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