I walked into my bank the other day and saw this advertisement:
“5/1 ARM: 3.875%, APR 3.675%!!!” (The exclamation marks were the bank’s, not mine).

This has always been one of my pet peeves because it seems so misleading, although technically, it’s the accurate way to calculate APR on an Adjustable Rate Mortgage (ARM). APR is all we have as a means of comparing interest rate quotes, but I promise you, you will be better off asking what the Note Rate is and how much it costs you to refinance before analyzing APRs.

If you’re unfamiliar with what APR is, you can brush up on it in a previous blog post I wrote: http://loansbyireneblog.com/2008/10/06/what-is-apr/

You’re probably curious why a loan that costs you money reflects an APR that is less than the interest rate you will be paying your mortgage at. The reason is that the bank assumes after your loan enters adjustment, it will adjust based on today’s Index + Margin (which trust me, this will not happen). Because of our poor economy, Indexes are extremely low, providing lower interest rates, and therefore quoted APRs on ARMs are less than the actual Note Rate.