A mortgage has a 6.00% note rate but a 6.24% APR. Why can the APR be higher than the note rate?
Correct Answer
B) APR reflects the interest rate together with applicable prepaid finance charges and other credit costs
Why this is correct: The Annual Percentage Rate (APR) is a broader measure of the cost of credit than the note rate. It is expressed as a yearly rate and includes the interest rate (note rate) plus certain other costs of obtaining the loan, such as prepaid finance charges (e.g., points), mortgage insurance premiums, and some closing costs. By incorporating these additional fees, the APR provides a more complete picture of the loan's total cost, which is why it can be higher than the note rate. Why the other choices are wrong: The choice "APR measures only property taxes" is wrong because APR has nothing to do with property taxes. The choice "APR is the property's appreciation rate" is wrong; APR is a loan cost metric, not a measure of property value growth. The choice "APR excludes all lender fees by definition" is wrong; in fact, the opposite is true—APR includes certain lender fees and other finance charges. Exam tip: When you see a higher APR than note rate, remember it's because the APR adds in certain loan costs. The note rate is just the interest rate.
Why This Is the Correct Answer
Why this is correct: The Annual Percentage Rate (APR) is a broader measure of the cost of credit than the note rate. It is expressed as a yearly rate and includes the interest rate (note rate) plus certain other costs of obtaining the loan, such as prepaid finance charges (e.g., points), mortgage insurance premiums, and some closing costs. By incorporating these additional fees, the APR provides a more complete picture of the loan's total cost, which is why it can be higher than the note rate. Why the other choices are wrong: The choice "APR measures only property taxes" is wrong because APR has nothing to do with property taxes. The choice "APR is the property's appreciation rate" is wrong; APR is a loan cost metric, not a measure of property value growth. The choice "APR excludes all lender fees by definition" is wrong; in fact, the opposite is true—APR includes certain lender fees and other finance charges. Exam tip: When you see a higher APR than note rate, remember it's because the APR adds in certain loan costs. The note rate is just the interest rate.
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