Debt guide
What interest rate are you really paying?
The rate on the offer sheet is not what the loan costs. Fees paid up front raise the real rate, the shorter you hold the loan the worse it gets — and the lender's own APR legally leaves several of your costs out.
There are at least three different "rates" attached to any loan, they are all correct, and they answer different questions. Knowing which is which is most of the skill in comparing offers.
Three rates, three jobs
The note rate is what your payment is calculated from. It is the number everyone quotes and it says nothing about what the loan cost to obtain.
The APR folds certain up-front charges back into a rate, so two loans with different fee structures can be compared. It is a better number than the note rate, and it has a specific legal definition that matters — see below.
Your effective rate is what the money actually cost you, given everything you paid and how long you kept the loan. This is the one that answers "was this a good deal", and nobody discloses it, because it depends on a fact only you know: how long you hold the loan.
Why fees raise the rate more than they look like they should
A fee paid at closing is not spread evenly across the life of the loan. You pay it on day one and then recover it, slowly, through a lower monthly payment.
That makes the effective rate depend on time. $6,000 in fees on a 30-year mortgage spread over 360 payments is a small addition to the rate. The same $6,000 on a loan you refinance away after four years is spread over 48 payments instead, and the effective rate jumps.
This is the asymmetry worth internalizing: paying points and fees is a bet on keeping the loan. The shorter you hold it, the more expensive every up-front dollar turns out to have been. It is the same mechanism that makes a mortgage buydown a horizon question rather than a rate question.
Run your own fees and a realistic holding period through the effective interest rate calculator — the rate moves noticeably as you shorten the period, and that movement is the real cost of the fees.
The part about APR that almost nobody knows
APR is a legally defined figure, and the definition contains exclusions.
Regulation Z defines the finance charge as the cost of consumer credit as a dollar amount, including any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit. But for loans secured by real property, § 1026.4(c)(7) excludes a specific list of charges from the finance charge, provided they are bona fide and reasonable:
- Title examination, abstract of title, title insurance and property survey fees
- Document preparation fees — deeds, mortgages, settlement documents
- Notary and credit report fees
- Appraisal fees and inspection fees, including pest and flood-hazard determinations
- Amounts required to be put into escrow or trustee accounts
This is not a loophole a lender is exploiting — it is the rule, applied identically by everyone, and it does make APRs comparable between lenders. What it does not do is tell you what the loan cost you. Those are different questions, and the disclosed APR only answers the first.
It is also why the figure this site produces will differ from a lender's disclosed APR: it counts every cost you enter, because the question here is what you paid, not what has to be disclosed.
The other direction: APR versus APY
On the savings side the same idea runs backwards. APY includes the effect of compounding, APR does not. A 5% rate compounded monthly is an APY of about 5.12%. When you are borrowing, ignoring compounding understates the cost; when you are saving, it understates the benefit.
The short version: for borrowing, compare APRs. For savings, compare APYs. Comparing one against the other tells you nothing.
What to ask
- What are the total costs, in dollars, not as a rate? Then decide what they are worth to you.
- Which of these charges are excluded from the APR you quoted me? A loan officer who can answer this is worth keeping.
- How long do I realistically keep this loan? Then compute the effective rate over that period rather than the full term.
- What does this loan look like with zero fees? The no-fee quote and the low-rate quote bracket the deal, and the answer is usually one of the two ends rather than the middle.
A rate is a summary, and every summary throws something away. The useful habit is not distrusting the quoted number — it is knowing precisely what it left out.
Sources: Regulation Z § 1026.4, definition of the finance charge and the real-property exclusions in § 1026.4(c)(7).