Mortgage Confidential: Understanding APR -- comparing apples and apples

Mortgage expert David Reed invites Walletpop readers to ask him questions about real estate financing. leave your questions in the comment section of this post.

The Annual Percentage Rate, or APR, is perhaps one of the most abused and misunderstood numbers when applying for a mortgage loan. Enacted years ago as part of the Federal Truth in Lending Act of 1968, this well-intentioned government consumer protection statute (goodness, how many of those do we have?) did many things but mostly it confused everybody. Most loan officers will tell you that the APR is a meaningless number so don't pay any attention to it when what they really mean is they have no clue as to how it's calculated or why it's even there.

What it's supposed to do is allow consumers to easily compare mortgage rate quotes from one lender to another by comparing the APR number. The APR is correctly defined as the cost of money borrowed expressed as an annual rate. When you get a mortgage you get an interest rate to go along with it but typically the lender has other fees it wants to charge so those fees need to be factored into the mortgage rate to come up with an APR.

The larger the variance between your mortgage rate -- the rate your payments are actually based on -- and the APR means one lender has more "junk" fees than it's competitor and will show a higher APR. Or at least that's the theory.

APR numbers can be abused, but you as the consumer can help "un-confuse" the various loan officers who are wanting your business by establishing some ground rules when getting rate and fee quotes. APRs are only useful when comparing identical loans under the very same circumstances.

Don't compare a 6.00 percent rate quote with a 6.25 rate, the APRs won't make sense and don't compare APRs from different mortgage types such as fixed rates and adjustable rates. Ask for a quote with the same loan program, loan type and term at the same rate. When your quotes come back along with your closing cost estimate also ask for the Truth in Lending Statement, this is the document that will report your APR. The lender with the lower APR will be the lender with the lower closing costs.

And finally, don't let a loan officer tell you the APR is a meaningless number, it's not. As long as you're comparing the very same loan under the very same circumstances from different lenders it means a lot. And it also may mean your potential loan officer doesn't understand the APR. What else might he not understand?

Real estate finance expert David Reed is president of CD REED Mortgage Bankers in Austin, TX and author of Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You and Mortgages 101: Quick Answers to over 250 Critical Questions About Your Home Loan.
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