The annual percentage rate (APR) is an
interest rate that is different from the note
rate. It is commonly used to compare loan
programs from different lenders. The Federal
Truth in Lending law requires that mortgage
companies disclose the APR when they advertise a
rate. Typically the APR is found next to the
rate.
Example:
| 30-year fixed |
8% |
1 point |
8.107% APR |
|
The APR does NOT affect your monthly
payments. Your monthly payments are a function
of the interest rate and the length of the loan.
The APR is a very confusing number! Even
mortgage bankers and brokers admit it is
confusing. The APR is designed to measure the
"true cost of a loan." It creates a level
playing field for lenders. It prevents lenders
from advertising a low rate and hiding fees.
If life were easy, then all you would have to
do is compare APRs from the lenders/brokers you
are working with, pick the easiest one, and you
would have the right loan. Right? Wrong!
Unfortunately, different lenders calculate
APRs differently! So a loan with a lower APR is
not necessarily a better rate. The best way to
compare loans in the author's opinion is to ask
lenders to provide you with a good-faith
estimate of their costs on the same type of
program (e.g. 30-year fixed) at the same
interest rate. Then, delete all fees that are
independent of the loan such as homeowners
insurance, title fees, escrow fees, attorney
fees, etc. Add up all the loan fees. The lender
that has lower loan fees has a cheaper loan than
the lender with higher loan fees.
The reason why APRs are confusing is that
the rules to compute APR are not clearly
defined.
What fees are included in the APR?
The following fees ARE generally included in
the APR:
- Points––both discount points and
origination points.
- Pre-paid interest. The interest paid
from the date the loan closes to the end of
the month. Most mortgage companies assume 15
days of interest in their calculations.
However, companies may use any number
between 1 and 30!
- Loan-processing fee.
- Underwriting fee.
- Document-preparation fee.
- Private mortgage insurance.
- Appraisal fee.
- Credit-report fee.
The following fees are SOMETIMES included in
the APR:
- Loan-application fee.
- Credit life insurance (insurance that
pays off the mortgage in the event of a
borrowers death).
The following fees are normally NOT included
in the APR:
- Title or abstract fee.
- Escrow fee.
- Attorney fee.
- Notary fee.
- Document preparation (charged by the
closing agent).
- Home inspection fees.
- Recording fee.
- Transfer taxes.
An APR does not tell you how long your rate
is locked for. A lender who offers you a 10-day
rate lock may have a lower APR than a lender who
offers you a 60-day rate lock!
Calculating APRs on adjustable and balloon
loans is even more complex, because the future
rates are unknown. The result is even more
confusion about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with
a 15-year loan using their respective APRs. A
15-year loan may have a lower interest rate, but
could have a higher APR, since the loan fees are
amortized over a shorter period of time.
Finally, many lenders do not even know what
they include in their APR because they use
software programs to compute their APRs. It is
quite possible that the same lender with the
same fees using two different software programs
may arrive at two different APRs!
Conclusion:
Use the APR as a starting point to compare
loans. The APR is a result of a complex
calculation and not clearly defined. There is no
substitute to getting a good-faith estimate from
each lender to compare costs. Remember to
exclude those costs that are independent of the
loan.
