Interest Rates vs A.P.R.

I had a client of mine ask me about what APR was yesterday.

Over the phone I explained what it was . I know what it is. I understand it's weaknesses and why it was created and why it's the law to produce it. But in explaining it to my client I wasn't overly satisfied with my ability to clearly convey the concept.

So I went on the internet. In searching, I came across plenty of politically correct answers.
In essence that answer looks like this: "The A.P.R. is mandated and was created by the Feds to protect consumers and allow consumers to better compare loans." - NOT!

The truth is that the Fed's did mandate and create the concept of APR but they forgot to legislate specifically what fees had to be included in this and what could be excluded. - OOOOPS!

So the APR, while still being mandated by law, has been manipulated by lenders, brokers, and everyone concerned. It's now used as more of a sales tool, "Look! Our APR is less than theirs! *"

Too bad they don't have to legally add the asterix, if they did it might look like this...

*Although we have to include some fees into the computation of this figure, we don't have to add all the fees, as a matter of fact we intentionally left out a whole bunch of fees to make that number look better and then be able to advertise this APR as being somehow different than the other guys. While everything we are doing is within the law, there may be some ethical corners we are cutting in order to increase our sales. Remember, there's no truth in advertising - even in ours!

So what is the real answer? Here's the best answer I found on the internet.


What is the Difference Between the Interest Rate and the A.P.R.?

You'll see an interest rate and an Annual Percentage Rate (A.P.R.) for each mortgage loan you see advertised. The easy answer to "why" is that federal law requires the lender to tell you both.

The A.P.R. is a tool for comparing different loans, which will include different interest rates but also different points and other terms. The A.P.R. is designed to represent the "true cost of a loan" to the borrower, expressed in the form of a yearly rate. This way, lenders can't "hide" fees and upfront costs behind low advertised rates.

While it's designed to make it easier to compare loans, it's sometimes confusing because the A.P.R. includes some, but not all, of the various fees and insurance premiums that accompany a mortgage. And since the federal law that requires lenders to disclose the A.P.R. does not clearly define what goes into the calculation, A.P.R.s can vary from lender to lender and loan to loan.

The A.P.R. on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But ARMs were invented because the market index changes and makes fixed rate loans cheaper or more expensive to make -- that's why they're variable rate in the first placed!

So, A.P.R.s are at best inexact. The lesson is, that A.P.R. can be a guide, but you need a mortgage professional to help you find the truly best loan for you.

Note when you're browsing for loan terms that the A.P.R. will not tell you about balloon payments or prepayment penalties, or how long your rate is locked. Also, you'll see that A.P.R.s on 15-year loans will carry a higher relative rate due to the fact that points are amortized over a shorter period of time.