Annual Percentage Rate Below Interest Rate?

November 5, 2001 "In checking advertisements by mortgage lenders, several showed APRs on fixed-rate mortgages that were lower than the interest rate.  Is that possible�?� In principle, it is possible and some lenders do it.  But in many cases, the computer programs used to calculate the APR don't allow it. Fees that are included in the APR and that are paid by the borrower raise the APR above the interest rate.  This is the typical case. If the lender pays all the fees included in the APR, then the borrower doesn�t have to pay them and the APR will be the same as the interest rate.  Lenders generally offer different combinations of interest rate and points, including negative points, referred to as �rebates�.  If the borrower selects a relatively high rate on which the lender pays a rebate, the rebate is used to pay fees. Some lenders make a practice of offering rebates that will just cover all the fees included in the APR.  One of the reasons lenders do this is that when the APR and the interest rate are the same, borrowers are much less likely to ask them to explain what the APR is.  One of the major problems with the APR is that some upfront fees are not included in it.  Examples are title insurance, appraisal and credit report fees, and transaction taxes.  If the lender�s rebate is large enough to cover these fees, as well as all the fees included in the APR, the APR should be below the interest rate.  Evidently some lenders do calculate it in this way.  But all the lenders I know interpret the rules to mean that the APR can't be below the interest rate. Under their interpretation, any fees not included in the APR are ignored in the calculation.   This means that the APR on a �no-cost� mortgage where the lender pays all the settlement costs can be misleadingly high. Copyright Jack Guttentag 2002

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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