- advertisement -
Ask Dr. Don

APR vs. interest rate

Dear Dr. Don,
It would seem like the terms "APR" and "Interest Rate" would be fully understood by now. However, as much as I seek out what the differences are, I only end up with more questions.

Why is it that APR is considered an apples-to-apples comparison between lenders when the interest rate is what you'll be making monthly payments on? Why is it that interest rates are sometimes much higher than the APR, if the APR should be what you would be paying on the cost of the loan, including up-front closing costs?
Gary Goodfaith

Dear Gary,
It is confusing.

The nominal rate of interest is the rate used when calculating the interest expense on your loan. That's what most people consider to be the interest rate on their loan. The annual percentage rate (APR) on a loan includes some of the costs involved in procuring the loan and is meant to provide the consumer with an effective rate to use when comparing loans.

- advertisement -

The Truth-in-Lending Act is implemented by the Federal Reserve Board's Regulation Z and sets the standards for how APRs are calculated. Since lenders have to abide by these standards, there is a basis for comparison between loans.

The APR on a fixed-rate loan should always be greater than or equal to the nominal interest rate. For it to be lower would require that the lender rebate back to you some of your interest expense.

The disclosure of an APR is considered accurate if the rate disclosed is within an eighth of a percent more or less than the actual rate, or the actual rate rounded to the nearest quarter of a percentage point. (The Federal Reserve Board may also allow a greater tolerance to simplify compliance where irregular payments are involved.)

The U.S. Code, Title 15, Chapter 41 (Consumer Credit Protection) gives all the details about what is and isn't included in calculating the finance charge on your loan. Beyond the rounding permitted by law, the biggest problem in comparing APRs from different lenders is the lender's ability to estimate the closing costs that are included in the APR calculation.

Use the lenders' APRs to help you choose which loan. If the rates are close, you should dig deeper. Either ask the lenders to show you the costs they included in their APR calculations and discuss with them whether these costs are actual or estimated, or calculate your own APR for the competing loans.

Wheatworks gives you a free trial of their APR Calculator that allows you to compile your own APRs for competing loans.

-- Posted: Dec. 13, 2001

top of page
See Also
Just what is the APR?
Mortgage Rate Trend Index


National Mortgage Rates
Rates may include points.
30 yr fixed mtg 4.06%
15 yr fixed mtg 3.17%
5/1 jumbo ARM 3.54%

  Calculate your monthly payment  
  How much house can you afford?  
  Fixed or adjustable rate: Which is right for you?  

Mortgage Basics
Follow the process from house hunting
to closing.
How much can I afford?
How much is my payment?
What documents do I need?
What is a home inspection?
What is the closing?
Can I remove PMI?

Mortgage rates in your area  
Graph rate trends  
Credit scoring  
Mortgage basics

- advertisement -
- advertisement -