What is APR interest rate?

Interest rate graphicYou shopped for the “lowest” mortgage interest rate. You spoke to more loan officers than a politician running for office; but you finally found a great interest rate. The loan officer provided you with a loan estimate and explained all the fees associated with the purchase (or refinance). You’re glad all this mortgage stuff is done with. Now all you have to do is wait until the mortgage is processed and go to closing.

But then, after paging through your application papers, you spot a form called “FEDERAL TRUTH IN LENDING STATEMENT”.

On the form is a box titled ANNUAL PERCENTAGE RATE.  WHAT!!! . . . that’s not what the loan officer promised. Infuriated, you’re about ready to suit up like Arnold Schwarzenegger in Commando and have a talk with that loan officer. You were probably thinking he was too smooth, too confident, too reassuring. Must be a thief.

But before you call, read this . . .

Angry woman speaking on a phoneThe annual percentage rate is NOT the loan rate that you will pay on your mortgage loan. The Truth In Lending Disclosure is required under the Truth in Lending Act enacted June 29, 1968. This legislation was designed to prohibit larcenous lending practices (i.e. bait and switch, also known as lying).

Federal Truth In Lending Disclosure Statement ExampleThe APR rate is NOT the interest rate you will be paying on your mortgage or loan ! ! !

This form is required by the federal government and is designed to help you compare mortgage lenders using a formula that “blends” the closing costs into the mortgage rate for illustrative purposes only. For example, let’s say Lender A does not have any closing costs whatsoever, the APR rate and the rate you pay on the mortgage, called effective rate will be the same, but, if Lender B has a LOWER interest rate and high closing costs, the APR rate may be higher than Lender A.

Still confused? Here’s another example:

Let’s say you’re financing a glass of milk for one dollar, the effective interest rate and the APR rate will be the same, because nothing was added to the milk. But what if the restaurant took that glass of milk and added a couple of scoops of chocolate ice cream, and topped it off with a coving of whipped cream, and charged you two dollars? The APR would be higher because of the chocolate ice cream and whipped cream.

One more thing . . .

The APR calculation is different with adjustable rate mortgages and the hybrid mortgages. Hybrid mortgages are loans that are fixed some period of time (i.e. 1,3,5,7 or 10 years) and then adjust annually.

What is the difference between a mortgage interest rate and an APR?


There are many costs associated with taking out a mortgage. These include:
  • The interest rate
  • Points
  • Fees Other charges

The interest rate is the cost you will pay each year to borrow the money, expressed as a percentage rate. It does not reflect fees or any other charges you may have to pay for the loan. An annual percentage rate (APR) is a broader measure of the cost to you of borrowing money, also expressed as a percentage rate. In general, the APR reflects not only the interest rate but also any points, mortgage broker fees, and other charges that you pay to get the loan. For that reason, your APR is usually higher than your interest rate. If you have applied for a mortgage and received a Loan Estimate from one or more lenders, you can find the interest rate on page 1 under Loan Terms, and the APR on page 3 under Comparisons.

TIP:
  • Take care when comparing loan options to be sure you understand any differences between the terms being offered: Take care when comparing the APRs of adjustable-rate mortgage loans. For adjustable rate mortgage loans, the APR does not reflect the maximum interest rate of the loan. 
  • Be careful when comparing the APRs of fixed-rate loans with the APRs of adjustable-rate loans, or when comparing the APRs of different adjustable-rate loans.  
  • Be careful about comparing the APR of a closed-end loan, which includes fees, to the APR of a home equity line of credit, which doesn't. Don't look at the APR alone in determining what loan makes the most sense for your circumstances.
    SOURCE: Consumer Financial Protection Bureau (CFPB)