So often when I am reviewing loan disclosures with a client they get confused with what the heck APR is. It's a sort of sticker shock when they see that it's different from the interest rate we had discussed. I'm hoping that this will give everyone a little insight into frustrating little acronym known as A.P.R.
What is A.P.R.?
A.P.R. stands for Annual Percentage Rate. And with that ladies and gentlemen the confusion starts. Most borrowers look at their mortgage paperwork & see “percentage rate” and assume that the A.P.R. is their interest rate (or note rate). In fact, the A.P.R. is NOT your mortgage interest rate and is NOT the rate that is used to calculate your monthly mortgage payment. So what is A.P.R. and why do we need to know, or even care what the APR on a mortgage loan is?
Simply, it helps us compare apples with oranges on an even playing field. The A.P.R. is the TRUE cost of the credit you are applying for. Under Federal Law, the A.P.R. needs to be disclosed by all lenders in a document called the Truth in Lending Disclosure (T.I.L.). If you have purchased or refinanced a home, this is the document in the mortgage package that shows how much will be paid out over the term of the mortgage and what part is interest.
If I told you that you had a choice between two 30 year mortgage loan proposals with one having an interest rate of 4.75% and one having an interest rate of 4.50%, which one would you choose? It seems like the easy answer is the one that has an interest rate of 4.50%. But, it is really a trick question. Only knowing the interest rate on your mortgage loan tells us just part of what is needed to make an informed decision. What if I then told you the mortgage with the 4.50% interest rate had total costs of $10,000 and the mortgage with the 4.75% interest rate had zero total costs. This seems like a more difficult decision. Which one really is the better mortgage? That is where our friend A.P.R. steps in to clear things up. If you know where to look for the A.P.R. on your mortgage documents (and you do now – on the Truth in Lending), it will tell us the mortgage loan with an interest rate of 4.50% has an A.P.R. of 4.99% while the mortgage loan with an interest rate of 4.75% has an A.P.R. of 4.875%. So, really, the loan with the interest rate of 4.75% will cost the homeowner less on an annual basis and the loan with the 4.50% interest rate will cost the homeowner more on an annual basis.
When comparing mortgage offers, looking just at the interest rate only tells half of the story. A lower interest rate will always equal a lower monthly mortgage payment, but, other factors, like closing costs & mortgage insurance premiums affect the true cost of credit. The Annual Percentage Rate helps consumers evaluate the true cost of credit. But, as a caveat, the A.P.R. does not tell the whole story either. A.P.R. costs are calculated over the full mortgage term (30 years, 15 years, etc.). If the loan is paid off prior to the end of the term, the A.P.R. will have changed. The A.P.R. and interest rate percentages should be used as tools in determining which mortgage is appropriate and not as the final answer.
Take the time to ask questions and make sure that your loan officer explains things to a point where you are comfortable with his or her response. We are living in a new age of lending where the pendulum of regulation has swung completely the other way compared to 2005. Educate and inform.
John B. Saari
Direct Cell: 508-740-7442
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