The advertised or nominal interest rate on a mortgage is used to calculate the interest incurred on the amount of the loan, and the annual percentage rate includes this amount along with other expenses charged by the lender, says Investopedia. When comparing loans, borrowers should focus more on the APR.
The APR is a truer expression of the full cost of the loan because it includes the cost for such things as closing costs and lender fees, explains Investopedia. For example, if on a $100,000 mortgage loan the interest rate is 6 percent, the interest is then $6,000 a year until the principal begins to shrink. However, if fees and other costs add up to $2,500, then the loan amount becomes $102,500. Six percent of this is $6,150. In this case, the APR can be calculated as 6.15 percent of the original $100,000. The APR is normally higher than the nominal interest rate, although there are instances when it may be lower if the lender offers a rebate on the interest amount.
By law, lenders must reveal to potential borrowers the APR on any kind of loan, says Investopedia. This law has been enacted as a protection for consumers, ensuring that they are aware of the full range of costs of entering into any loan agreements.