Annual Percentage Rate (APR) Versus Interest Cost

February 8, 2006, Revised January 3, 2008

The APR is a special version of interest cost that is a mandatory disclosure under Truth in Lending.

"Some of your calculators calculate something called 'interest cost' but some others calculate APR, what are the differences and similarities?"

Similarities Between Annual Percentage Rate (APR) and Interest Cost (IC)

Both are "internal rates of return". This means that they combine the interest rate and other payments into a single measure of cost to the borrower. IC is a concept widely used as an investment tool. APR is best thought of as a special type of IC.

Differences Between Annual Percentage Rate (APR) and Interest Cost (IC)

The APR is a mandated disclosure under Truth in Lending.

The APR is always calculated over the term of the mortgage, whereas IC can be calculated over any period. An IC calculated over the period the borrower expects to have the mortgage is more accurate than the APR.

The APR includes only lender fees. IC can include third party fees as well, subject to the borrower’s selection. So long as the borrower is consistent in this selection, the IC is a more flexible measure.

APRs on adjustable rate mortgages (ARMs) assume that the rate index used by the ARM remains at its initial level. IC is more flexible in this regard, because it can be calculated with any scenario the user believes is relevant, including a worst case.