The annual percentage rate (APR) gives you the yearly cost
of a mortgage in the form of a percentage. The rate
calculations include interest, mortgage insurance, and the
origination fee (points).
The APR has two main purposes.
1. it allows borrowers to compare loan programs from
different lenders so they can see which program is the
cheapest.
2. It creates a "level playing field" for lenders. And,
three, it prevents lenders from advertising teaser rates
and hiding fees from consumers.
The Federal Truth in Lending law requires mortgage
companies to disclose the APR when they advertise their
rates. Typically the APR is found next to the rate; for
example, "30 year fixed...8%...1 point...8.107% APR."
APRs can be useful for consumers in determining the cost of
a mortgage; however, they do have one problem you need to
be aware of, and that problem is that APRs can be very
confusing because different lenders calculate APRs
differently! This means that a loan with a lower APR may
not actually have a better rate.
To find out the truth about a particular APR on a loan, you
have to do digging and calculations on your own.
The first step is to ask lenders for a good-faith estimate
of their costs on the same type of loan (e.g. 30-year
fixed) at the same interest rate.
Once you have the estimate, the second step is to delete
all fees that are independent of the loan (e.g., homeowners
insurance, title fees, escrow fees, attorney fees, etc.
The third step is to add up all the loan fees and then
choose the lender with the lowest loan fees.
You may wonder why there's so much confusion about APRs.
Well, there are several reasons
Reason 1:
The rules to calculate APR are not clearly defined.
APR is calculated using a complex formula prescribed by the
Consumer Credit Act (1980). But, there are three different
ways of calculating the Annual Percentage Rate! Lenders
must inform you of the APR calculation method before you
sign a loan agreement, but that doesn't mean it's easy to
understand.
Reason 2:
It's not always clear what fees are included in the APR.
The following information about fees will show you what I
mean.
A. Fees generally included in the APR are:
1. Points - both discount points and origination points a.
Pre-paid interest. Note: This is 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, some will use any number between 1 and 30.
2. Loan-processing fee
3. Underwriting fee
4. Document-preparation fee
5. Private mortgage insurance
B. Fees sometimes included in the APR:
1. Loan-application fee 2. Credit life insurance (insurance
which pays off the mortgage in the event of a borrower's
death).
C. Fees not normally included in the APR:
1. Title or abstract fee
2. Escrow fee
3. Attorney fee
4. Notary fee
5. Document preparation (charged by the closing agent)
6. Home-inspection fees
7. Recording fee
8. Transfer taxes
9. Credit report
10. Appraisal fee
Reason 3:
The APR doesn't tell you how long your rate is locked in
for. This means that one lender who offers you a 10-day
rate lock may actually have a lower APR than a lender who
offers you a 60-day rate lock.
Reason 4:
APR calculations for adjustable and balloon rates are
complex.
The future rates for adjustable and balloon rates are
unknown, so calculating APRs becomes very complex. This
results in more confusion for borrowers.
Reason 5:
Comparing APRs of different loans creates false comparisons.
Consumers sometimes make the mistake of comparing the rates
of different loans; i.e., comparing 30-year loans with
15-year loans using the respective APRs.
Example: A 15-year loan may advertise a lower interest
rate, but have a higher APR because the loan fees are
amortized over a shorter period of time. So, don't ever
compare the two!
Reason 6:
Different lender computer software programs may calculate
different APRs Lenders often use computer software programs
to calculate their APRs and don't even know what baselines
are used in these programs. Worse, the same lender with the
same fees may use two different software programs. It's
entirely possible that these programs may calculate two
different APRs!
Here are my two recommendations in regard to the APR:
First, use the annual percentage rate only as a starting
point when dealing with lenders.
Second, as I mentioned earlier, get good-faith estimates
from lenders and then exclude any costs that are
independent of the loan.
Key Point: When it comes to APRs, do your homework!
Jack Sternberg
----------------------------------------------------
Jack Sternberg is a nationally recognized expert on real
estate investment and the creator of the renowned "Buyers
First Program" who's been in the business for more than 30
years. Sternberg's deals have totaled over $750 million and
he's been to the closing table more than 1,500 times. For
more, visit http://www.askjacksternberg.com
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