What is Mortgage APR, Can You Explain It?

Mortgage and Lending with LoanOfficerSchool.com NMLS 291249


APR Demystified

First, lets demystify the calculation for Annual Percentage Rate (APR).

Mortgage APR was designed to allow consumers to use one standardized number to compare each lender's rate for the same type of loan while rate shopping.  It is supposed to represent the borrower's cost and it works like this.

If I lend you, $10,000  and, I charge a $500 Bump-ta-Bump Fee, you will actually receive $9,500, however you must still repay me Mortgage APR$10,000.  Mortgage APR is my real yield and your real cost on this loan.

We agreed that you will repay the loan at 8% interest on $10,000, HOWEVER you only received $9,500 therefore I will earn more than the 8.0% interest rate I charge on $10,000.  In this case, my yield (APR) is 9.799% on the $9,500 you actually received.   

APR is the lender's yield on dollars actually lent ($10,000 minus $500 = $9,500); in this case, the lender's yield (APR) on $9,500 is 9.799%   (APR is computed as if the above example is a 30 year loan)

The $9,500 also represents the Amount Financed in the Truth In Lending (TIL) disclosure. 

For those of you who use spreadsheets the Rate Function will find APR.  Use the Amount Financed for Loan Amount and use the monthly payment on the actual loan amount.

Fees that must be subtracted from a mortgage loan to properly calculate Amount Financed for APR

  • Origination and Discount Points
  • Processing and Lender Fees
  • Pre-Paid Interest (Use 15 days when closing date is unknown)
  • Monthly Mortgage Insurance must be added to the payment of all FHA loans and Conventional loans greater than 80% loan to value. 
  • The inclusion of Mi or MIP accounts for the large spread between Rate and APR on loans with mortgage insurance.


NOTES:  FeesNot used in APR calculation; third party fees such as appraisal and credit.  APR can only be compared on loans of the same type and amortization period

How Do APR Predators Work?Mortgage APR Predator

Many sophisticated borrowers shop interest rates by searching for lowest APR which, if property stated, is a valid way to compare similar loans.  Unfortunately, APR is not always stated properly.

How is advertised Mortgage APR is misstated? 

  • Prepaid Interest is not included - most common deception and true on all online Rate sites   i.e.: Bankrate.com, Interest.com, Mortgage101.com, ShopRate.com, etc.
  • Prepaid Interest is understated - must be 15 days when closing date is unknown.
  • MI or MIP is not included in the APR on any online rate sites, Bankrate etc.
  • Some lenders do not include MI or MIP on their web sites such as Amerisave.com 
  • Lender fees are either understated or not included in the APR calculation.  This is a tricky one because No or Low Lender Fees does not necessarily indicate a predatory lender.  Some lenders charge a higher rate and no points or fees for their so called "Zero Cost" loan.  However, the "Zero Cost" rate will always be higher than a rate with points and/or fees. 
  • Notes to the above: 
    • there is no such thing as a Zero Cost loan and some states prohibit lenders from advertising Zero Cost Loans.
    • The spread between Rate and APR on loans greater than 90% LTV should be at least 0.700%.  When it is not... you are being scammed

Rate - Points - Fees are all interdependent

The best way I can explain this is show various Rate - Point - Fee combinations where the lender is making the same gross profit on each combination

In the examples below, we will use a $200,000 loan amount and Lender gross profit of $1,000, on a day when the Lender's cost for a 5.000% rate is par (0 point).

Best Rate:  $1,000 Lender profit in various combinations of points and fees





















Lowest Fees:
Increase the rate to 5.125% and you pay $0 points and fees and Lender's investor pays the lender $1,000 for the higher rate.  











The point here is that lenders design their loans to provide talking points for their sales staff (loan officers).  They all require a certain profit margin and it is not important the way the loan is structured as long as the closed loan delivers their required profit margin. 

This illustration also points out the value of correctly stated APR as a way of comparing mortgage loans.  For the sake of these illustrations, prepaid interest was not used.  If 15 days PP was calculated it would have increased each APR by 0.019%.


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Bill Ladewig
LoanOfficerSchool.com - Escondido, CA
Experience Is Your Advantage

Sharon, unfortunately many loan officers cannot explain APR. Use APR as a test when enterviewing LOs.  If they cannot explain it to you they cannot explain it to their borrowers.

Paddy, unfortunately you are correct.  That is why borrower education is so important.

Jan 26, 2013 01:22 AM #181
Steven Cook
No Longer Processing Mortgages. - Tacoma, WA

Bill -- what a great explanation of the APR that people are supposed to be using, so by extension so many lenders are abusing.  The one other thing that I usually notice on "Lowest rates" advertising is that they are limiting it to 15 years, and then requiring 70 or 80% LTV -- it would be interesting if everyone had to use the same loan amount, over the same period, with same LTV - for their example.

Jan 26, 2013 03:21 AM #182
Bill Ladewig
LoanOfficerSchool.com - Escondido, CA
Experience Is Your Advantage

Steven, that is really a great idea.

Jan 26, 2013 03:32 AM #183
Charles Stallions
Charles Stallions Real Estate Services - Pensacola, FL
800-309-3414 - Pensacola, Pace or Gulf Breeze, Fl.

That about puts it in simpliest of terms and easy to read and understand. Good Luck Bill and Happy Posting

Apr 04, 2013 09:56 AM #184
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

Thanks for this explanation.  I must admit I find all of this quite confusing.. if the government thought APR was going to make it easier for consumers, I think they missed the boat.

Apr 04, 2013 11:21 AM #185
Fred Griffin Tallahassee Real Estate
Fred Griffin Real Estate - Tallahassee, FL
Licensed Florida Real Estate Broker

Good explanation.  I have been at this a long time; nothing is as confusing to Borrowers/Buyers (and Realtors) as APR!

Apr 04, 2013 12:32 PM #186
John G. Johnston
John G. Johnston & Associates, LLC - Westcliffe, CO
An Exclusive Buyer's Agent ~ Westcliffe, CO

Bill Now you have scared the bejiggers out of me.  I feel like a buyer or seller that read an article on Zillow or Trulia and now knows the market!  I'm beginning to feel like an expert!  Well written and thanks

Apr 04, 2013 12:35 PM #187
Wika Hutchinson
Eugene, OR

Thank you for sharing a great information Bill. I enjoyed reading your post.

Apr 04, 2013 05:05 PM #188
Randy Hilman REALTOR® Associate Broker
Randy Hilman Homes - Moultonborough, NH
Guide & Mentor to Home Buyers & Sellers

Hi Bill:

Informative blog.  I thank you for sharing it.  I need to work through some of your examples with my HP12C.

Apr 04, 2013 09:46 PM #189
Gary L. Waters Broker Associate, Bucci Realty
Bucci Realty, Inc. - Melbourne, FL
Fifteen Years Experience in Brevard County

I am not sure many consumers understand the difference between interest rate and APR.

Apr 07, 2013 09:43 AM #190
Bill Ladewig
LoanOfficerSchool.com - Escondido, CA
Experience Is Your Advantage

Thanks all for your comments.

Charles, thank you, a simple mind is able to state things simply.

Joan, there is a lesson here about politicians doing most things.

Fred, Kind of what I said to Joan.  Politicians can even screw up a good idea.

John, thanks. The good news is that we can never know too much.

Wika, I enjoyed that you read my post.

Randy, a good man with a HP12C can rule the world.

Gary, you are correct and that causes problems for those cannot explain the difference.

Apr 08, 2013 07:37 AM #191
Sharon Alters
Coldwell Banker Vanguard Realty - 904-673-2308 - Fleming Island, FL
Realtor - Homes for Sale Fleming Island FL

Bill, I have a more complete understanding of APR thanks to your very thorough explanation. Deducting the fees from the amount borrowed and calculating the interest on that amount - now I understand it!! And the example of how the lender can arrive at the same gross profit depending on what the borrower can stand or is willing to pay is very helpful. Thanks!! Sharon

Jun 26, 2013 12:12 PM #192
Richie Alan Naggar
people first...then business Ran Right Realty - Riverside, CA
agent & author

The first time I tried to explain this many years ago, I taught myself a lessen in GIBBERISH...In other words, I dint know and wouldn't admit. Today I have enough sense to say, that is a good question ask a loan officer

Jun 27, 2013 12:14 AM #193
Bill Ladewig
LoanOfficerSchool.com - Escondido, CA
Experience Is Your Advantage

Hi Sharon, I am pleased the article helped.  Thanks for your comment.  

Hi Richie.  It is a shame that APR is so confusing.  You are right, it is a good question for loan officers.

Jun 27, 2013 12:25 AM #194
Alicia Mandel

I'm a new loan officer. I tell people the way it really works, that nothing is free in lending, and try to show them. The other companies don't do that. I don't think people really care because they see what they want to see whether it's no points, lower fees or a lower rate. There is already so much for a new homebuyer to learn. They should teach this in school. Thank you for your explanation.

Mar 24, 2016 05:32 AM #195
Bill Ladewig
LoanOfficerSchool.com - Escondido, CA
Experience Is Your Advantage

Alicia, I totally agree with your comments.  "Points" are confusing to most borrowers and "they" otta teach it in school.  One way to explain points is to show a side by side cost comparison for 3 or 4 different rates, including a zero cost rate.

Best of luck with your lending career.  You get to be a part of one of the three most important events in most people's lives.  Marrage, giving birth and buying a home.

Mar 24, 2016 05:53 AM #196


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