When you borrow money the bank quotes an interest rate they will charge on your money. The comparison rate, also known as the annual percentage rate (APR), determines the true interest cost of the loan when your payments are combined with other costs such as administration fees.
Suppose you took a mortgage for $300,000 with a 30-year interest rate of 6 percent. Your monthly payment would amount to $1,768. Now suppose you also have to pay $7,500 in up-front fees and $3,000 in closing costs, which are added to your mortgage, resulting in a new monthly payment of $1,830. The comparison rate, or APR, is the equivalent interest rate of a $1,830 monthly payment to the original $300,000 mortgage, or 6.34 percent APR.
Truth in Lending Act
U.S. federal law requires lenders to prominently display the comparison rate on any advertising. This is why when you see a TV commercial, for example, showing mortgage lending rates, the ad will display the mortgage rate, followed by the comparison rate, or APR, which is generally higher than the advertised mortgage rate.
Costs Not Included in APR
Some borrowing costs do not factor in the comparison rate calculation, such as home appraisal, title search and credit reporting fee. This does impose some limitations on the usefulness of the comparison rate.
The comparison rate has more meaning for fixed rate than adjustable rate mortgages. The comparison rate for adjustable rate mortgages will be based on a fixed rate, and future rate fluctuations will affect the accuracy of the comparison rate calculation.