Updated: May 29, 2019
Does the APR quoted in an advertisement matter? Is it hiding something?
The simple answer is “Yes, it matters; but can be deceiving”. APR is the rate you are paying for the money you borrow, taking into consideration all costs of borrowing (i.e. Note Rate, Fees, Adjustment periods and adjustment caps for adjustable rate mortgages). APR was designed by regulators to help borrowers compare apples to apples when examining loan options, by giving borrowers a rate that considers all important aspects of a loan.
The Problem: In the real world, when you compare APR quotes, you may be comparing apples to oranges. There is discretion in how APR is calculated. Two lenders who are really offering the exact same loan can have different APR’s; this is especially true with adjustable rate mortgages. So, you can’t effectively compare the two offers without breaking them down into their component parts.
If you are comparing 30-year fixed mortgages, the lender’s published APR can be helpful. For example, if the note rate is 5.5% and the APR is 5.75%, you are paying approximately 2-points to get that rate. This is simplified, but a good rule of thumb.
With adjustable loans, the published APR is notoriously unreliable. There are several problems with how APR is calculated for adjustable loans:
Adjustable Rate Mortgages consider the adjustment caps and many other pieces of information that do not affect the cost to get the loan in points.
The APR calculation assumes that when the rate adjusts (i.e. in 5 years when the fixed portion of a 5-year ARM is over) it will adjust to the rate it would be if it adjusted today. Of course, the index changes monthly; so, the odds that it will be the same several years from now are slim.
APR calculations also assume that when the rate adjusts, it will stay the same for the rest of the term of the loan; which is also not true.
So then, how can you compare loan offers fairly?
It is simple. When reading advertised rates, think twice before trusting it, especially for an ARM loan. Always get the actual costs before making a decision. Ask the lender to tell you the points cost for any rate you are considering and the lender fees. That’s it!
I hope this article helped you. If you have any questions, contact me at Holly@HollyGustlin.com or