As the federal government years ago attempted to help consumers more easily compare interest rates from multiple lenders, the Annual Percentage Rate, or APR was developed. In theory, this calculation would allow consumers to choose the best deal. But most, including many individual loan officers themselves, stumble when explaining what the APR actually represents. When someone applies for a mortgage, they’ll receive no shortage of paperwork and one of the more prominent pieces included in that paperwork is the Truth in Lending disclosure, or TIL.
The TIL attempts to provide a clear path to help consumers compare rates. Unfortunately, because the APR stands out so much on the TIL, many times the consumer begins to think there’s somewhat of a ‘bait and switch’ going on because the APR will be higher than the actual note rate on the mortgage. The note rate is one of the components used when calculating the monthly payment.
It goes something like this. A consumer gets a rate quote from a loan officer, submits an application and within three days, a host of disclosures are sent over. The APR stands out and will be higher than the initial rate quote. When the consumer then calls the loan officer and asks for an explanation, many loan officers stumble in the response.
Many times, the loan officer can even say, ‘don’t pay any attention to the APR number, it’s just a disclosure we have to provide.’ But that’s the wrong response. The correct response is ‘The APR is the cost of money borrowed expressed as an annual rate.’ That’s it. An experienced loan officer will be able to easily explain this disparity. Nothing more. The APR reflects some closing costs associated with getting the new mortgage. But understanding the APR can be another story.
The disparity between the note rate and the APR shows which lender is charging more lender fees. Two mortgage lenders can quote the very same 30 year rate, but the APR can be different. How does that work? If Lender A and Lender B both quote 3.5% for a 30 year rate, the computed APRs might result in something closer to 3.62% and 3.84%. Still, the monthly payments remain the same, only that Lender B obviously has higher lender fees than Lender A. In this example, Lender A would appear to be the better choice.
Further still, the APR can only be used as a comparison tool when comparing mortgages of the same loan term. An APR for a 20 year fixed can’t be used to compare with a 30 year note. The loan term is a key component when calculating the APR number. The APR number is a valuable tool but only when properly evaluated. When used properly however, the APR does indeed serve consumers well. But when a loan officer insists it’s not that important and has trouble just explaining what it is, it might be time to start looking elsewhere for your financing needs.