What Is Annual Percentage Rate (APR)?

Truth-In-Lending snapshot

More commonly called APR, Annual Percentage Rate is a government-mandated mortgage comparison tool. It measures the total cost of borrowing over the life of a loan into dollars-and-cents.

A loan’s APR is printed in the top-left corner of the Federal Truth-In-Lending Disclosure, as shown above. When quoting an interest rate, loan officers are required by law to disclose a loan’s APR, too.

APR is meant to simplify the process of choosing between two or more loans. The theory is that the loan with the lowest APR is the “best deal” for the applicant because the loan’s long-term costs are lowest. However, the loan with the lowest APR isn’t always best.

APR makes assumptions in its formula that can render it misleading as a comparison tool.

  • First, APR assumes you’ll pay your mortgage off at term, and never sooner. So, if your loan is a 15-year fixed rate, its APR is based on a full 15 year term. If you sell or refinance prior to Year 15, the math used to make your loan’s APR becomes instantly flawed and “wrong”.

For Example: Let’s compare two identical loans in California — one with discount points and a lower interest rate; and one without discount points and a higher mortgage rate. The loan with discount points will have a lower APR in most cases. However, if the homeowner sells or refinances within the first few years, the loan with the higher APR would have been the better option, in hindsight.

  • Second, APR can be “doctored” early in the loan process.

Because the APR formula accounts for third-party costs in a mortgage transaction, and third-party costs aren’t always known at the start of a loan, a bank can ‘inadvertently’ understate them…..it’s a loan officers last dirty secret to try and trick you into believing they have a better deal when shopping APR’s. This would make the APR appear lower than what it really is, and may mislead a consumer.  I have even seen some lenders not count the Up Front Mortgage Insurance fee on an FHA loan or the Funding Fee on a VA or USDA loan.  Since this can be a large dollar figure, it can make one offer look way better than another competing offer if not calculated in the APR.

  • Third, APR is not helpful comparing adjustable-rate loans. Because the APR calculation makes assumptions about how a loan will adjust during its 30-year term, if two lenders use a different set of assumptions, their APRs will differ — even if the loans are identical in every other way. The lender whose adjustments are most aggressively-low will present the lowest APR.

Read this for more info on The Difference Between Note Rate and APR Rate.

Summarized, APR is not the metric for comparing mortgages — but it is a metric. For relevant comparison points, call me @ (951) 215-6119.

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