The interest rate is your cost to borrow the money, expressed as a percentage rate.
Another way to think of the interest rate is as “rent” on the money. The principal and interest portion of your monthly payment is first applied to the interest that accrued in the previous month, and the remaining portion of the payment reduces your principal. Over time, as you pay down principal, less and less of your monthly payment goes towards interest and more and more to principal until the loan is finally paid to $0.
What your interest rate does NOT do is reflect the fees and charges you paid in order to obtain the loan. This is where APR comes in.
The annual percentage rate (APR) reflects both the interest rate AND your cost to obtain the mortgage. The APR reflects points, lender fees, mortgage insurance, closing attorney fee, recording fee and per diem interest, converts them to a percentage which is added to the interest rate to reflect a rate that is always higher than the interest rate.
APR or “annual percentage rate” was created to show you the total cost of the loan – including the interest rate AND the loan fees such as any points, lender fees, and other charges that you pay to get the loan and that you would not have paid if you paid cash to buy the home. These fees are considered “prepaid finance charges” because you prepay them at closing to get the loan. For that reason, your APR will be higher than your interest rate.
The APR for an adjustable rate mortgage does not reflect the maximum interest rate for the loan – and so APRs for adjustable rate mortgages are not very useful.
There are some other issues with comparing APRs, primarily because paying points for a lower rate does increase APR, but receiving a lender credit in exchange for selecting a higher rate does not reduce APR – except for the big banks. They have a strong lobby, and are allowed to use a lender credit to reduce your APR. Logically, ALL LOANS receiving a lender credit should apply it to reduce APR, in my opinion.
Regulators require that all lenders disclose an APR whenever they quote an interest rate. The idea is that APR will be helpful when comparing different offers. But comparing offers from a bank, like Wells Fargo or Bank of America, and a correspondent lender like Corporate Investors Mortgage Group is tricky.
And so offers from But if a correspondent lender or a broker gives you the exact same lender credit and it covers any or all of your closing costs, the credit is NOT factored into your APR. For this reason, offers from banks can be misleading.
For example, you could have an offer directly from Wells Fargo that shows a rate of 4.75%, APR fees of $2325 and a lender credit of $2325 – with an APR of 4.764% – and I could give you exactly the same offer but the APR for my offer would be higher.
In the examples below – just looking at Rate and APR doesn’t tell the whole story. Remember that offers C and D can’t reflect the lender credit in the APR.
In this chart showing 4 offers, offer A looks best if you just look at the APR. And offer B looks just as good as offers C and D. But offer C is $1000 better than offer B and equal to offer A, and offer D is the best of these 4 offers.
|Offer A||Offer B||Offer C||Offer D|
|Bank of America|
|a “broker” or “correspondent lender”||Frank Rexford / Corporate Investors Mortgage Group|
For an accurate comparison – you must look at rate, APR fees, Lender Credit and APR. Other fees, such as third party fees, will be the same for whichever lender you choose, so they are not useful in making comparisons. Attorney fees, title insurance fees, homeowner’s insurance premiums, and insurance and tax escrows are not controlled by the lender and they do not impact APR.
Call me at 919-929-6116 if you would like me to explain why D is the best choice.
*APR fees illustrated include Commitment Fee, Credit Report Fee, Flood Certification, Appraisal Fee, Attorney Fee and Per Diem Interest.
NOTE – APR calculations make unrealistic assumptions when calculating APR for ARM’s. The calculations do not take into account how high your rate could actually adjust, and so APR is not helpful.