What is APR?

The Annual Percentage Rate (APR) represents the comprehensive yearly cost of borrowing funds under a mortgage or credit agreement, expressed as a percentage. Unlike the nominal interest rate, which only measures the base interest charged on the loan principal, the APR incorporates the interest rate plus other mandatory finance charges and upfront fees required to secure the loan. Under the federal Truth in Lending Act (TILA), implemented via Regulation Z, lenders are legally mandated to calculate and prominently disclose the APR on the Loan Estimate and Closing Disclosure. This standardization prevents lenders from advertising deceptively low base rates while masking the true cost of credit in hidden upfront fees.

In a residential mortgage, the APR calculation typically factors in the nominal interest rate, lender origination fees, loan processing and underwriting fees, document preparation fees, discount points (prepaid interest), and private mortgage insurance (PMI) premiums. Conversely, third-party fees that are not considered finance charges (such as title insurance, settlement agent fees, homeowner's insurance, credit report fees, and appraisal costs) are generally excluded from the APR. Because it aggregates these upfront financing expenses, the APR is almost always higher than the nominal interest rate. It serves as the primary benchmark for borrowers to make an accurate, direct comparison of loan offers across different lenders. However, because mortgage payments are calculated solely from the nominal interest rate, the APR does not dictate the actual monthly payment amount.