Truth In Lending | Annual Percentage Rate | APR

What's APR?   What's the Annual Percentage Rate?

You shopped for the “lowest” 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 good faith 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 (or parachute in), read this . . .

The annual percentage rate is NOT the interest 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).

The 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 lenders using a formula that “blends” the closing costs into the interest 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.

Notice that the APR rate and the effective interest rate is the same with Lender A. That's because there are not closing costs. Now look at Lender B and Lender C. You will notice that the APR rate increases with the amount of the closing costs added to the APR formula.

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.

Who has the lowest interest rate?    Who is the best lender?

All three lenders are charging an "effective" interest rate of 5%, but notice how the APR rate increases with the closing costs. 

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.

The APR cost calculator will estimate the closing costs between different fixed rate mortgages. Proceed to the calculator