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 place!  

When you're browsing loan terms, keep in mind the A.P.R. does not tell you anything about balloon payments or prepayment penalties, or how long your rate is locked.  Also, A.P.R.s on 15-year loans will carry a higher relative rate due to the fact that points and fees are amortized over a shorter period of time.

In summary, using  an A.P.R. as a shopping tool isn't the best way of shopping for a mortgage but it is a good starting point. The best way to shop for a mortgage is to compare rates and fees on the same day, for the same product and with the same interest rate.

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