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.
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 APRs 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:
The
following fees are normally NOT included in the APR:
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.
