For years we all have heard, "What is the APR for that loan? The APR is more important than the interest rate." " You must compare the APR from different lenders." Well, let's take a look at how APR is calculated and what it means.

APR means "annual percentage rate" and is shown on the Truth in Lending Disclosure. It is the interest rate that will amortize or pay off, with specific monthly payments, over 30 years, the amount you borrow after reducing the amount borrowed by certain closing costs as determined by Federal Regulation Z. Sounds simple, right?

As an example, a $300,000 loan at 5 percent has a payment of $1,610.46 per month. If the closing costs allowable for the APR calculation are $3,000, then the APR becomes 5.089 percent.

The purpose of the APR is to compare loan programs to determine which loan is the most cost-efficient over 30 years. The fees shown on the Good Faith Estimate are used to calculate the APR, which is shown on the Truth in Lending form. This is where the trouble starts.

Although Reg Z specifically states what items are to be eliminated from the loan amount in calculating APR, lenders can mistakenly use different amounts. Or lenders may also advertise low rates and not calculate the APR correctly.

Recently, I saw a lender advertising a 30-year fixed loan at 4.875 percent with no points and an APR of 5.20 percent. To create an APR of 5.20 percent from a 4.875 percent interest rate requires closing costs to equal approximately $11,000, which would indicate about 3 points in fees.

The APR calculation for an adjustable-rate mortgage is even more complex. Different interest assumptions must be assumed over the 30-year calculation based on the adjustable formula. Even more possibilities for errors can occur.

My recommendation when a borrower is comparing loan costs is twofold. First, certainly get a Good Faith Estimate and the Truth in Lending statement that describes the APR for your loan from different lenders and compare the APR. Then isolate the important parts of the Good Faith that represent what the lender is charging. Look at the interest rate and the lender's fees. This is what the lender is charging for the loan.

Title company fees, appraisal fees, prepaid interest and escrows for future taxes and insurance (which are also shown on the Good Faith) are not charges from the lender and will be the same no matter what lender does your loan.

Disclosures required to protect consumers and homeowners are valid and important, such as the APR calculation. But don't stop there — do your own analysis and understand exactly what is being charged by the lender. "Buyer beware" is an old but true adage.


Jim Gay was a real estate broker for 20 years and has been a consultant to Fortune 500 companies. He is senior loan officer/ Partner with Superior Mortgage Services ( 505-988-4422) in Santa Fe.