APR stands for Annual Percentage Rate. It is one of the most misunderstood numbers when people apply for loans. As mortgage loans have become more complicated, it has become necessary to regulate the way lenders advertise and notify the potential borrower of their interest rates.

The APR is an attempt to help individuals compare similar loans from lenders and to explain the total cost of credit they will be borrowing. The APR is defined as the cost of credit to the borrower in relation to the amount borrowed expressed as a yearly rate. This is required by the Federal Truth in Lending Act, Regulation Z.

When you apply for a mortgage, you will receive the Federal Truth in Lending Disclosure form. In the following boxes, you will see lots of numbers. As you will notice, the APR is slightly higher than the note rate. This is because the APR includes other items associated with obtaining a mortgage.

Even the same loan can vary in the APR section due to associated costs. The following is an example of the top boxes of the T-I-L (Truth in Lending) form. The main difference in the two loans is the origination fee. Loan #1 has a 1 point (or 1%) origination fee, and loan #2 has a 2 point (or 2%) origination fee. As you can see, the first box is the APR. The APR varies due to the total of the closing costs. The Finance Charge box reflects the difference between the Amount Financed box and the Total of Payments box.

Here's an example of the need for all information to determine the best overall contract. Mr. and Mrs. Brown want to buy an $175,000 home. The loan amount will be $150,000. The Browns have two loans to compare. The loan is $150,000 at 7.125% for a 30-Year fixed rate mortgage. The monthly payments are exactly the same ($1,001.58).

The developer of the project has a mortgage agent and offers an interest rate similar to what they could get at ABC Mortgage. The developer's agent offers 7.125% fixed with no points (Loan #1 below). ABC Mortgage also quotes 7.125% with no points but has an origination fee equal to 1 percent of the loan amount (Loan #2 below).

Here's the tricky part! The developer's agent failed to disclose there is a 2 percent origination fee! What looked like a better deal with the developer's agent turned out to be a more costly loan. If the APRs were given, this higher cost would be evident. In this instance, the APR for the developer would be 7.331% and ABC Mortgage's A.P.R calculates to 7.229%. The loan with the developer's agent is not the best deal due to the higher fees charged. Even though the note rate (the rate used to figure monthly payments) was the same, it cost more at the developer's agent. Therefore, Mr. and Mrs. Brown will be better served to choose the mortgage from ABC Mortgage.

Loan #1 Developer's Agent

Loan #2 ABC Mortgage

The APR utilizes the costs paid out of your pocket for the loan to identify a true cost of loan. Even though you may pay for items out of your pocket, and not include them in the loan, these costs are still incurred to obtain the loan. Therefore, they should be included in an overall cost analysis for you to obtain the loan.

In the example above, with the purchase, you will pay for items such as processing, underwriting, etc. out of your pocket. These will not be included in the loan amount. However, they are still costs to you in order to obtain the loan. There will be a calculation to include the impact of these costs to your overall cost. You will not pay any more for the loan over time. You will need to have all of the information to determine the best loan based on APR.

The following fees ARE generally included in the APR:

• Points--both discount points and origination points
• Pre-paid interest. The interest paid from the date the loan closes to the end of the month
• Loan-processing fee
• Underwriting fee
• Document-preparation fee
• Private mortgage insurance
• Appraisal fee
• Credit-report fee

The following fees are NOT normally included in the APR:

• Title insurance or abstract fee
• Escrow fee
• Attorney fee
• Notary fee
• Title or Attorney Document preparation (charged by the closing agent)
• Home inspection fees
• Recording fee
• Transfer taxes

Remember the higher the loan amount, the less impact additional fees or points will have on the APR. Why? If you obtain a mortgage with $3,000 in closing costs and you borrow $10,000, then the $3,000 will be nearly 30% of the loan amount. This increases the cost of your money dramatically. Usually home equity or home improvement loans show a higher disparity between note rate and APR because of this. Now, with the same closing costs of $3,000 for a $100,000 loan, the impact is equivalent to 3% of the loan.

Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.