Understanding APR - Annual Percentage Rate

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! The APR is designed to measure the "true cost of a loan". It attempts to create a level playing field for all lenders. It prevents lenders from advertising a low rate and hiding fees.

The best way to compare loans in our opinion is to ask lenders to provide you with a Loan 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.

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 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

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!

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.