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Mortgages > Purchase

APR or Annual Percentage Rate
What is an APR?  When a loan officer explains it to me I still don’t get it.

In all my years in the lending business, I found that one of the most difficult lending terms to explain (especially over the phone) was APR.

The conversation would often be like this:

Customer: What is my APR?
Loan Officer: Your APR is 6.42%

Customer: I can see my APR says 6.42% on the documents you sent me but what I asked is what is my APR?
Loan Officer: 6.42% APR

Customer: You told me the rate I am paying is 5.75% fixed mortgage rate and now you are saying it’s 6.42%!
Loan Officer: Your mortgage note rate is 5.75% but the annual percentage rate or APR is  6.42%.

Customer: How can I have two different rates on the same loan?
Loan Officer: You don’t have two different rates, let me explain (OH OH! here we go, I think to myself.) APR or annual percentage rate is different than the note rate because it  reflects some of the closing costs.

Customer: So, what rate am I paying?
Loan Officer: 5.75%

Customer: This makes me suspicious.  It looks like I’m paying 6.42% APR
Loan Officer: You are.

At this point my conversation would evolve to me asking the customer to get a piece of paper and a pen and I would try to have him write some numbers on it that would illustrate how the APR calculations were used to arrived at 6.42% APR and it would more often than not, leave the customer confused by the apparent silliness of APR.

At some point in the past, probably as result of consumer complaints, the government regulators and the lenders wanted to have some method of clearly explaining to the consumers the total costs of a loan.  This was mainly driven by unscrupulous lenders that would advertise a very low interest rate but load the loan with very high fees (junk fees) that would make up for the low rate.

Thus, APR or annual percentage rate was invented. Apr was supposed to be the single reference that a consumer could use to determine and compare the cost of his loan with other lenders.  Many places warn the customer to compare the APRs when shopping for a loan.

In the real world however, I found that these “informed consumers” had very little or no idea what they were comparing. Even though the lenders and the regulators meant well, APR did not reduce loan cost confusion but added to it.

I will now try to explain how APR works.  (For simplicity of the example the calculation will be illustrations but not accurate)

Loan   amount:   $100,000.00
Rate: 5.75%
Payment $550.00
Fees: $4000.00 (included in the loan amount)
Term: 30 years
APR: 6.42%

To calculate the APR you subtract the fees from the loan amount ($100,000.00 minus $4000.00 = $96000.00) and using the same payment ($550.00) recalculate what the interest rate for 30 years would now become. 

The APR is supposed to give an accurate and real cost of the loan including additional fees applied to the loan.

Despite my many years of experience in consumer finance and the mortgage business I personally do not think APR accomplishes what APR was intended to do. A single reference to loan cost simply doesn’t work with the average consumer.  A better method should be used such as loan cost spread sheet.

However, APR is the currant method and it seems APR is here to stay.  Good luck finding your lender and happy APR hunting.

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