What is the difference between the interest rate and the A.P.R.?

You'll see an interest rate and an Annual Percentage Rate (A.P.R.) for each mortgage loan you see advertised. The easy answer to "why" is that federal truth-in-lending law requires the lender to tell you both.

The A.P.R. is a tool for comparing different loans.  If borrowers make several calls to shop for the best deal, they may get different quotes, which might include different interest rates, but also different points and other terms. The A.P.R. is designed to represent the "true cost of a loan" and, in most instances, the borrower can usually consider the lowest A.P.R to be the best deal. This way lenders can't "hide" fees and upfront costs behind low advertised rates.  You can actually compare this method of disclosure to the unit pricing that supermarkets display on grocery shelves. We sometimes call the A.P.R. our industry's way of giving borrowers their "price per pound" on the interest rate!

We frequently receive quote inquiries from borrowers who make a reference to a low interest rate they saw on a highway billboard.  They failed to take note of the A.P.R. that was, in some cases, almost 1/2% higher than the interest rate posted.  What the 1/2% difference tells a trained professional is that there are SIGNIFICANT costs associated with obtaining that interest rate.

While it's designed to make it easier to compare loans, it's sometimes confusing because the A.P.R. includes some, but not all, of the various fees and insurance premiums that accompany a mortgage. And since the federal law that requires lenders to disclose the A.P.R. does not clearly define what goes into the calculation, A.P.R.s can vary from lender to lender and loan to loan.

The A.P.R. on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But ARMs were invented because the market index changes and makes fixed rate loans cheaper or more expensive to make -- that's why they're variable rate in the first placed!

So, A.P.R.s are at best inexact. The lesson is that A.P.R. can be a guide, but you need a mortgage professional to help you find the truly best loan for you.

Note when you're browsing for loan terms that the A.P.R. will not tell you about balloon payments or prepayment penalties, or how long your rate is locked. Also, you'll see that A.P.R.s on 15-year loans will carry a higher relative rate due to the fact that points are amortized over a shorter period of time.