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 mortgage companies to
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,
all you would have to do is compare APRs from the
lenders/brokers you are working with, then 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. Now 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 because 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
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
- Credit report
- Appraisal fee
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 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.
