APR

The Annual Percentage Rate, commonly shortened to APR, is a method used to compare loans from different lenders. Lenders are required by federal law (The Federal Truth in Lending Act) to disclose APR when they advertise their rates. The APR prevents mortgage companies from dishonestly advertising low rates through the use of hidden fees and upfront costs. Instead, the APR strives to show borrowers the true cost of the mortgage, by expressing the cost as a yearly rate.

One consequence of the APR method that confuses some consumers is the appearance of a higher APR for 15 year loans, as opposed to 30 year loans. This is because the points on 15 year loans are amortized, or spread out, over a shorter period, making the APR higher.

When companies make a disclosure of the costs of a loan (called a Regulation Z), prepaid interest is also included in the calculation of APR. You should be careful, however, because APRs include some, but not all, of the fees and insurance premiums that go along with a mortgage. Because the rules for calculating APR have not been defined in detail, which fees and charges are included vary according to lender. That means the final APR numbers will be different across lenders as well.

APRs may also be misleading when you are dealing with a loan that is variable, or tied to a variable market index. In calculating APR, the assumption is that these indexes will never change, which is not the case. This may also lead to a number that can't be used to make accurate comparisons between lenders and/or loans.

Finally, there are aspects of your mortgage that APRs will not reflect, such as balloon payments or the length of time your rate is locked in. While all of these facts are problems with APR, the number may still be useful for a quick and dirty shopping comparisons. However, you should not rely on APR alone in determining if a mortgage is right for you.