Question: I recently settled on a home and obtained a 5/1 adjustable rate mortgage (ARM) at 6.375 percent. In looking over my papers, I realized that at the time of application my loan officer gave me a Truth-In-Lending (TIL) statement that showed my annual percentage rate (APR) to be 7.548 percent. Then, at the settlement table, I signed another TIL that indicated an APR of 5.687 percent. My note says that my interest rate is fixed for five years at 6.375 percent. So I have three very different rates to look at. Can the mortgage people get it together and tell me what's going on?

Answer: Oh, boy -- my favorite subject -- TIL bashing. Congratulations on discovering the stupidity of the federal Truth-In-Lending statement.

Let's talk about this.

The TIL Statement is a well-intentioned but very poor disclosure that is supposed to give an accurate indication of the true cost to borrow expressed as an interest rate, which is known as the Annual Percentage Rate, or "APR."

Let me describe the APR exactly as I describe it to my clients applying for a mortgage.

The APR takes into consideration:

1. Any costs associated with obtaining the loan.

2. Any possible future adjustments to your note rate.

Let's look at the first item. If I lend you $100 for one year at an interest rate of 10 percent, at the end of the year you pay me my principal balance of $100 plus ten percent interest, or $10. In this case your note rate and APR is 10 percent because there were no costs incurred to obtain the loan.

However, let's say I agree to lend you $100 for one year at ten percent but I charge you an up front fee of $1. You would then pay me $1, I would lend you $100, and in one year you would pay me my $100 principal back plus the $10 in interest.

In this case your note rate is still 10 percent because you are paying $10 in interest, but since it cost you a dollar up front to get the loan, your APR will go up. So the bottom line here is that the higher the costs to obtain the loan, the higher the APR.

To make matters worse, the APR doesn't take into consideration all the fees typically charged on a home purchase. It considers points and appraisal costs, but not settlement or attorney's fees, for example. But then it considers prepaid interest as a cost. Prepaid interest is merely interest, not a cost.

Now let's look at the second item.

You took out a 5/1 ARM, which means your note rate is fixed for the first five years at say 6.375 percent. After five years, your rate will adjust annually thereafter based on a particular index -- usually the yield on the one-year treasury bill.

This is another dopey thing about the APR: How on earth can a lender give an accurate APR on a rate that will change in the future? Who thought this up? Since we know that in five years your rate will start changing, it's impossible to calculate an accurate APR for an ARM.

The reason you received two very different APRs from your lender is probably because they used two different index values in the calculation.

One more silly thing about the TIL: It assumes you will hold the loan for the entire term. So if you have a 30-year fixed rate the APR is calculated on the assumption that this loan will not be paid off early because of a sale or a refinance. And since the average mortgage loan in this country is held for only about six years, this means that the APR is inaccurate for virtually every mortgage applicant.

So, I say forget about the APR. To compare rates accurately, you need to look at the rates of identical mortgage programs -- say one FHA loan versus the same FHA loan from another source -- and contrast the total fees associated with each loan.

For more articles by Henry Savage, please press here.

Published: December 26, 2001

Use of this article without permission is a violation of federal copyright laws.

, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.