Annual Percentage Rate (APR)

APR vs. Interest Rate

The interest rate determines the monthly payment amount, while the APR reflects the overall cost of the loan including fees. Federal law under the Truth in Lending Act (TILA) requires lenders to disclose the APR so borrowers can compare offers on an equal basis. A loan with a lower interest rate but higher fees may have a higher APR than a loan with a slightly higher rate and lower fees.

What APR Includes

The APR calculation typically incorporates:

• Origination fees charged by the lender
• Discount points paid to buy down the rate
• Mortgage insurance premiums (when required)
• Certain prepaid interest and closing costs

Not all closing costs are included. Title insurance, appraisal fees, and recording fees are generally excluded from the APR calculation. This means the APR, while more comprehensive than the rate, still does not capture every cost associated with obtaining a mortgage.

Using APR to Compare Loans

APR is most useful when comparing loans with the same term and structure. Comparing the APR on a 30-year fixed to a 5/1 ARM is misleading because the ARM's APR assumes the initial rate applies for the full term, which it does not. When comparing two 30-year fixed-rate offers, the loan with the lower APR generally costs less over the full term, assuming the borrower holds the loan to maturity. Borrowers who plan to sell or refinance within a few years should weigh upfront costs more heavily than the APR suggests.