Using APR to Compare Loans and Mortgages

Many borrowers understand that the APR, or Annual Percentage Rate, is a calculation of all costs associated with a mortgage, expressed as a yearly rate. Since the Federal Truth in Lending law requires that this figure be disclosed whenever mortgage rates are advertised, it has become somewhat of a mortgage comparison benchmark. However, as you’ll see after reading this article, the APR should not be the only thing considered when comparing mortgages.

Originally devised as a way to prohibit lenders from being able to advertise low rates while hiding from potential customers other fees and costs associated with a loan, lenders have found ways to get around this. Although the law in theory is good, it failed to clearly define guidelines for calculating APR. That has led to inconsistencies in its calculation. Different lenders offering different mortgage products define APR differently, causing much confusion, even among lenders.

One point of confusion with the APR is that it is calculated over the full term of the loan. This is an assumption since many borrowers won’t hold on to their loan for the full term. Therefore, APR should not be used to indicate a loan’s value.

For variable mortgage products tied to certain indices, APR calculation assumes the indices are static. However, they constantly move, which invalidates this assumption. As a result, the number derived is unreliable for use in comparing mortgage costs among different lenders.

Lastly, the Annual Percentage Rate does not include other costs such as loan prepayment penalties, balloon payments, or the length and/or fee associated with a rate lock in. When one loan has a lower APR than another, it does not always mean the lower APR loan is the better choice. It may not be which is why APR should only be used as a very general guideline when shopping different lenders for mortgage products. Before choosing a particular loan, it’s crucial to consider all of the associated costs. If there are some costs you don’t understand, ask for clarification. That’s the best way to feel confident you’re getting the best deal.