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.
