(1.) Annual Percentage Rate is an expression of the effective interest rate that the borrower will pay on a loan, taking several things into account. In other words, the APR is the total cost of credit to the consumer, expressed as an annual percentage of the amount of credit granted. APR is intended to make it easier to compare lenders and loan options.

(2.) The APR is a comprehensive measure of credit cost to the borrower that takes account of the interest rate, points, and flat dollar charges. It is adjusted for the time value of money, so that dollars paid by the borrower up-front carry a heavier weight than dollars paid several years down the road.

 Calculating the APR

The APR is calculated on the assumption that the loan runs to term, and is therefore potentially deceptive for borrowers with short time horizons. In order to calculate the APR the lender will tabulate the entire interest to be paid over the life of the loan. See Amortization to see how they get this figure. Once we have this figure we then add whatever upfront fee's have been charged to the total interest paid over the life of the loan. The interest rate is then recalculated factoring in the up front lending fee's. 

For example:                                                                                                                                                                                                 

With a Loan of $200,000 @ 6% the borrower will pay a total of $231,676 in interest over the life of the loan.
If the borrower is charged a total of $10,000 in closing costs the total cost to borrow the money would be as follows

$231,676 + $10,000 = $241,676 - the APR calculation is difficult, but there are various calculators on the net to figure out your APR

In the above example once the closing costs are factored in your APR 6.485% vs. your quoted rate of 6%

Difference between Note Rate and APR

The APR is likely to differ from the "note rate" or "headline rate" advertised by the lender, due to the addition of other fees that may need to be included in the APR.

In the US and the UK, lenders are required to disclose the APR before the loan (or credit application) is finalized.

Bankapedia's Take

Having to show APR is something lenders lobbied against for yrs, however in 1968 HUD rolled out the Truth in Lending Act, otherwise known as TIL. Prior to the Truth in Lending act, lenders would stack a loan with fee's but keep the interest rates low for marketing purposes. The APR represents the true cost of borrowing the money.

If you watch Ditech commercials you notice they switch between one of two types of marketing campaigns. They either advertise a low low rate or they have a promotion where there are no fee's charged. The low rate loan will typically have a fairly high APR, because they are charging a lot of up front fee's in order to offset the fact they are making little to nothing on the loan itself. This type of loan will typically show a large disparity between the rate and the APR - i.e. a Rate of 4.6% APR 5.7%. The other type of loan, the low up front fee loan, will typically carry a higher than market rate and the lender will make their money in Yield Spread Premium. A low up front loan will have an APR that is very close to the qouted rate. i.e. Rate of 5.6% APR of 5.9%.

So make sure to pay close attention to your TIL, because lenders want to make as much off you as they can. Fee's are just as important as rate, especially if you plan on refinancing anytime soon.

References

Guttentag, Jack. "Mortgage Glossary". 2007 

"Wikipedia". 2007 <http://en.wikipedia.org/wiki/Annual_Percentage_Rate>.