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.
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
What fees are included
in the APR?
The following fees ARE generally
included in the APR
• Points - both discount points and origination
• 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
• 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
• 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
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
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!
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.