Borrowers routinely confuse note rate and APR, and MLOs who cannot articulate the difference clearly risk compliance problems and borrower complaints. Understanding the Regulation Z calculation methodology is not optional for any mortgage originator.
What the Note Rate Represents
The note rate (also called the contract rate or interest rate) is the annual interest rate stated on the promissory note. It determines the actual interest portion of each monthly payment. When a borrower makes their P&I payment, the interest portion is calculated using the note rate applied to the outstanding principal balance.
What APR Represents
- ✦APR is a standardized disclosure metric under Regulation Z (TILA) that reflects the true cost of credit over the loan's projected life
- ✦APR includes the note rate plus the cost of prepaid finance charges -- origination fees, discount points, certain third-party fees that the lender requires
- ✦Not all closing costs are included in APR: title insurance, appraisal, and certain other fees may be excluded depending on their classification
- ✦APR is always higher than the note rate when finance charges are present; they can be equal only if there are zero finance charges
How APR Is Calculated
APR is the internal rate of return that equates the present value of all future mortgage payments to the amount of credit extended (loan amount minus prepaid finance charges). The calculation assumes the loan runs to its full amortization term. On a 30-year mortgage with discount points, the APR will be higher than the note rate by the amount that the prepaid charges inflate the effective cost when spread over 30 years.
APR Tolerances and Cure Requirements
Under TILA, the APR disclosed on the Loan Estimate must be accurate within a 1/8th of 1% tolerance for regular transactions. If the disclosed APR changes by more than this tolerance before closing, a new Closing Disclosure must be issued and the borrower must receive a new 3-business-day waiting period. Lenders who fail to cure an APR tolerance violation face TILA liability. This is why MLO-quoted APR figures must align with the disclosed finance charges.
Aria can explain how prepaid finance charges affect APR, what is included versus excluded in the APR calculation, and how to identify when an APR tolerance is triggered. Ask at vicariointel.com.
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