What is APR?

APR is an acronym for "annual percentage rate." It is different from interest rate shown on note, and it is (typically) slightly higher. Failure by a mortgage broker to disclose the APR in accordance with Department of Real Estate regulations could result in loss of a license.

In spite of the importance attached to the need to disclose the APR figure, it is only a calculated figure. It never appears on the note borrowers sign. It never is used to figure the amount of payment a borrower must make to repay the amount borrowed. It is never used to calculate another figure. So what good is it and why is it necessary to disclose it? Essentially, the APR is the result of an effort to inform borrowers of the "true cost" of borrowing money on a home loan. As such, it represents not only the interest rate that appears on the note, but also it includes the costs of getting the loan. Thus, the theory goes, borrowers are better informed and can make more accurate decisions.

The basic calculation involved in determining the APR is quite simple - for fixed rate loan. It is also simple for adjustable rate loans, but, as we will explain later, less meaningful. Those with HP12C calculators or the like can easily make this calculation. Here's how it works.

First, enter the loan amount, the term of the loan, and the interest rate and solve for monthly payment. We'll do it for you - $400,000 loan at 6.5% for 30 years - monthly P&I payment is $2,528.27.

Next, reduce the loan amount by the estimated cost of getting the loan. Title costs, appraisal, underwriting, credit report and other "Non-recurring costs" may total $3,500. So you now have a loan amount of $396,500.

Apply the monthly payment of $2,528.27 to this new (lower) loan amount and solve for interest rate. The resultant figure (6.593%) is the APR. Let us say that in addition to the normal nonrecurring costs of $3,500, the borrower pays 2 points. We deduct another $8,000 from the loan amount, giving a revised loan amount of $388,500. Using the same original monthly payment of $2,528.27, and solving for interest we get a new APR of 6.81%.

Without this disclosure, a borrower may not realize the impact of paying points on the cost of his loan. So there is justification for the requirement to disclose. And the figure does have some meaning when applied to a fixed rate loan.

The calculation for adjustable rate loans is essentially the same as for fixed, however, since the calculation on a variable rate loan is based on the "fully indexed" rate, the APR figure is less meaningful for ARMS.

Depending on what happens to the underlying index between now when the loan becomes fully indexed (three, five, seven, or ten years from now) the rate could be wildly different. But still it must be disclosed. The APR figure for an adjustable rate loan is meaningless, but essential. If this seems like a contradiction in terms, it is.