The Veridian Blog

The annual percentage rate (APR) is an interest rate that is different from the Note Rate that is used to compute monthly payments.  The Federal Truth in Lending Law (Regulation Z) requires banks and mortgage companies to disclose the APR when a potential borrower applies for a loan and when they advertise a particular program's interest rate.  The legislation was written to create a level playing field for potential borrowers to shop and compare loan programs from different lenders.   What often gets missed in the analysis, however, is that APR is merely an estimate to measure the “true cost of a loan” and offers little protection to the consumer if the lender fails to adhere to the estimate.

In practice, APR is a very confusing calculation because the rules to compute APR are not clearly defined so different lenders calculate APR differently!  So a loan with a lower APR does not necessarily translate into better note rates or terms.  The better way to compare loans is to examine the Good-Faith Estimate of their closing costs on the same type of program (i.e. 30-year fixed) at the same interest rate.  Then exclude from analysis all fees that are independent of the loan such as homeowners insurance, govt. transfer taxes, title fees, escrow fees, attorney fees, etc., before adding up all the loan fees.  The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.

But even after that, APR comparisons have inherent flaws: 1) APR is an estimate by definition and as long as lenders publish APR in good faith, there is no obligation to meet the terms of the stated APR, should rates and fees change by the time closing occurs; 2) APR does not necessarily 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; 3) Calculating APR on adjustable and balloon loans can be misleading because future adjustable index values are unknown; 4) When comparing a 30-year loan with a 15-year loan, 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, and; 5) 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!

The bottom line is that APR is a good starting point to compare loans but is not a conclusive decision-making vehicle.  For more information on what fees are and are not typically included in APR calculation, please email me…