The first misconception is that the APR (Annual Percentage Rate) is the rate of interest that you pay on the loan. APR is NOT the interest rate used to calculate your loan payments. If this were the case, lenders would not quote the Interest Rate and APR separately. Interest Rate and APR are two completely separate things.

The Interest Rate (not APR) is the true rate of interest that you are paying on your loan. This means that if you get a loan with an Interest Rate of 7.500%, your monthly payments are calculated at 7.500% regardless of what your APR is. Pretty simple.

The APR shows you what your "effective" interest rate is after calculating loan fees into the equation. Take a look at this example:

John borrows $150,000 from Beacon Mortgage at an Interest Rate of 7.500% for 30 years. John's monthly payment for this loan is $1,048.21.

Now we will look at what the APR is based on different closing costs for the same loan. What you will see is that the more costs you have for the loan, the higher your APR will be. The monthly payment and true Interest Rate will not change. There is no need to worry if your APR and Interest Rate don't match, because they rarely will. Check out the table below:

As you can see, as the cost of John's loan increases so does the APR, but the monthly payment always remains the same because the Interest Rate is the same. This should be a clear indication that APR does NOT determine your monthly payment, but merely expresses the existence of loan costs.

The actual calculation for APR itself is a little confusing. However, you can be confident that the APRs lenders quote you will be correct, since an accurate APR calculation is a Federal requirement for all lenders. Here is another example of how to use APR in the real world.

Let's say that you are looking for a new mortgage and you see advertisements from three different lenders in the Sunday paper. Here is a comparison between the rates and APR that each lender is advertising:

By looking at the numbers, you immediately know that Lender C will have the lowest monthly payment. Why? Because they are offering the lowest Interest Rate.

Remember: forget the APR. The bottom line is that the lowest Interest Rate will always equal the lowest monthly payment regardless of the APR. To demonstrate, take a look at the table below to see what the monthly payment will be for each lender based on a loan amount of $150,000:

Now, the remaining question is: "What is the difference between Lender A and Lender B?" In looking at the tables above you will see that the only difference between them is the APR. The Interest Rate is the same and thus, the monthly payment is the same. So again, what exactly does the difference between the two APRs tell you?

Well, if you remember that APR is really a way of indicating loan fees, then it should be pretty clear that Lender B is charging more in loan fees than Lender A. It's that simple.

Hopefully you can now read and understand Interest Rates and APR a little more clearly. The most important thing to remember is that the Interest Rate is what actually affects your monthly payment, not the APR.