Your mortgage broker is at least half right. The APR, which stands for "annual percentage rate", is a good idea badly executed that is as likely to mislead consumers as help them.
One of the reasons shopping for a mortgage is so hard is that the cost of a mortgage includes more than just the interest over the life of the loan. In most cases lenders also want you to pay them some cash up front. Some of the cash charges, referred to as "points", are quoted as a percent of the loan amount. Other cash charges, sometimes called "junk fees", are a fixed dollar amount regardless of the size of the loan.
Here is an example. Loan A has an 8% rate, 1 point and $350 in other fees while B has a 7.5% rate, 4 points and $100 in fees. Which is the better deal? You are right to scratch your head, since it is not at all obvious.
The intent underlying the APR is a good one. It is designed to make it easier to shop for a mortgage by pulling together the different components of the price into a single comprehensive cost of credit. Then mortgages could be compared on an "apples to apples" basis. A comparison of APRs in the example indicates that B is the better deal, since the APR is 7.93% compared to 8.14% on A.
But is the answer right? It is if your loan runs for its full term. Returning to the example, assume a loan of $100,000 and that the loan runs for 30 years. On loan B you would pay $4100 up front, or $2750 more than on A, but you would save on interest relative to A in every subsequent month. In the first month that saving is $41.66 and over 360 months it adds up to more than $12,000. The interest savings on B outweigh the larger up front cost by a substantial margin. This is what the lower APR on B tells us.
The problem is that about 90% of all borrowers pay off their loans before term when they buy another house or refinance their mortgage. Expected early loan termination can shift the balance of advantage between the loans being compared.
Suppose a borrower choosing between A and B expects to be in the house only 5 years, for example. Then the larger up front cost on B stays the same at $2750, but the interest savings on B now run for only 5 years rather than 30, and accumulate to only about $2500. Loan A now becomes the better deal and the lower APR on B is flat-out wrong for that borrower.
The remedy is to make the APR "borrower specific" -- calculated for each borrower over the period specified by the borrower. Where the borrower has not yet been identified, as in newspaper ads, several APRs should be shown, e.g., 3 years, 7 years and term. But the Federal Reserve Board, the agency with regulatory responsibility, is not going to do this anytime soon.
Meanwhile, use the APR only if you believe you will be in your house 10 years or longer. If your time horizon is shorter, ignore the APR and shop by specifying the rate and requesting a complete itemization of all the credit charges you will be required to pay with that rate. With the rate fixed, the best deal is the one carrying the lowest total fees.
