The Annual Percentage Rate, commonly referred to as the APR, is an oft-misunderstood term. Granted the mortgage world has a lot of different terms that can be a head-scratcher sometimes, but the APR is right up near the top, if not the top, of the list. And the confusion typically starts when borrowers first receive their initial loan disclosures. The APR is simply defined as the cost of money borrowed expressed as an annual rate. But even some loan officers have trouble explaining the APR. Sometimes they can mention to ignore the APR altogether because it’s not important.
When potential borrowers start making a few phone calls to different mortgage companies to compare rates, it’s fairly straightforward. The loan officer answers the phone, gets a little information and provides a rate quote. Once the borrower decides where to apply, the wheels begin to turn. Lenders are required by statute to provide certain loan disclosures within three days of receiving an application. The Loan Estimate will feature the estimated loan amount, current rate for the day the quote is prepared, and the APR, among other items. But here’s where it can get tricky.
The rate quoted over the phone is the note rate. That’s the rate used to calculate the monthly payment. The monthly payment includes both the principal and interest. If the borrowers choose or are required to have impounds or escrow accounts, the monthly payment will also include an amount for taxes and insurance. But when consumers receive their estimate within that three day period, one of the things they’ll notice is the APR, prominently displayed. However, the APR won’t be the same as the note rate. Why? Because the APR takes into consideration not just the interest rate but also additional fees to pay for other services and documents. These additional services and documents include both lender and non-lender fees.
The APR was initially designed to help borrowers compare loan choices among different lenders. And while that’s true in reality it’s not all that helpful. Why? Rates change daily, sometimes intraday. They proper way to use the APR is to compare the note rate with the APR. If there is a slight discrepancy, that means there are lower fees involved. The note rate might be 3.50 percent and the APR 3.52 percent. But if the note rate is 3.50 percent and the APR is 3.75 percent, there are a lot more fees at play here.
That’s the APR. It’s the cost of money borrowed expressed as an annual rate. It’s not something to be ignored, but understanding its purpose and how it’s calculated can help consumers better understand their initial loan disclosures.