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 home 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 home 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 A.P.R is designed to make it easier to compare home 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 home loan to home loan.

The A.P.R. on a home 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 home 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 home loan for you.

Note when you're browsing for home 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.