APR
stands for Annual Percentage Rate. It is one of the most
misunderstood numbers when people apply for loans. As mortgage loans
have become more complicated, it has become necessary to regulate
the way lenders advertise and notify the potential borrower of their
interest rates.
The APR is an
attempt to help individuals compare similar loans from lenders and
to explain the total cost of credit they will be borrowing. The APR
is defined as the cost of credit to the borrower in relation to the
amount borrowed expressed as a yearly rate. This is required by the
Federal Truth in Lending Act, Regulation Z.
When you apply
for a mortgage, you will receive the Federal Truth in Lending
Disclosure form. In the following boxes, you will see lots of
numbers. As you will notice, the APR is slightly higher than the
note rate. This is because the APR includes other items associated
with obtaining a mortgage.
Even the same
loan can vary in the APR section due to associated costs. The
following is an example of the top boxes of the T-I-L (Truth in
Lending) form. The main difference in the two loans is the
origination fee. Loan #1 has a 1 point (or 1%) origination fee, and
loan #2 has a 2 point (or 2%) origination fee. As you can see, the
first box is the APR. The APR varies due to the total of the closing
costs. The Finance Charge box reflects the difference between the
Amount Financed box and the Total of Payments box.
Here's an
example of the need for all information to determine the best
overall contract. Mr. and Mrs. Brown want to buy an $175,000 home.
The loan amount will be $150,000. The Browns have two loans to
compare. The loan is $150,000 at 7.125% for a 30-Year fixed rate
mortgage. The monthly payments are exactly the same ($1,001.58).
The developer of
the project has a mortgage agent and offers an interest rate similar
to what they could get at ABC Mortgage. The developer's agent offers
7.125% fixed with no points (Loan #1 below). ABC Mortgage also
quotes 7.125% with no points but has an origination fee equal to 1
percent of the loan amount (Loan #2 below).
Here's the
tricky part! The developer's agent failed to disclose there is a 2
percent origination fee! What looked like a better deal with the
developer's agent turned out to be a more costly loan. If the APRs
were given, this higher cost would be evident. In this instance, the
APR for the developer would be 7.331% and ABC Mortgage's A.P.R
calculates to 7.229%. The loan with the developer's agent is not the
best deal due to the higher fees charged. Even though the note rate
(the rate used to figure monthly payments) was the same, it cost
more at the developer's agent. Therefore, Mr. and Mrs. Brown will be
better served to choose the mortgage from ABC Mortgage.
Loan #1 Developer's
Agent
| Annual Percentage
Rate |
Finance Charge
|
Amount Financed
|
Total of
Payments |
| The cost of your credit
as a yearly rate. |
The dollar amount the
credit will cost you. |
The amount of credit
provided to you or on your behalf. |
The amount you will
have paid after making all payments as scheduled.
|
| |
| 7.331% |
$217,301.02 |
$146,504.69 |
$363,805.71 |
Loan #2 ABC Mortgage
| Annual Percentage
Rate |
Finance Charge
|
Amount Financed
|
Total of
Payments |
| The cost of your credit
as a yearly rate. |
The dollar amount the
credit will cost you. |
The amount of credit
provided to you or on your behalf. |
The amount you will
have paid after making all payments as scheduled.
|
| |
| 7.229% |
$215,801.02 |
$148,004.69 |
$363,805.71 |
The APR utilizes
the costs paid out of your pocket for the loan to identify a true
cost of loan. Even though you may pay for items out of your pocket,
and not include them in the loan, these costs are still incurred to
obtain the loan. Therefore, they should be included in an overall
cost analysis for you to obtain the loan.
In the example
above, with the purchase, you will pay for items such as processing,
underwriting, etc. out of your pocket. These will not be included in
the loan amount. However, they are still costs to you in order to
obtain the loan. There will be a calculation to include the impact
of these costs to your overall cost. You will not pay any more for
the loan over time. You will need to have all of the information to
determine the best loan based on 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
- Loan-processing fee
- Underwriting fee
- Document-preparation fee
- Private mortgage insurance
- Appraisal fee
- Credit-report fee
The following fees are NOT
normally included in the APR:
- Title insurance or abstract fee
- Escrow fee
- Attorney fee
- Notary fee
- Title or Attorney Document preparation
(charged by the closing agent)
- Home inspection fees
- Recording fee
- Transfer taxes
Remember the
higher the loan amount, the less impact additional fees or points
will have on the APR. Why? If you obtain a mortgage with $3,000 in
closing costs and you borrow $10,000, then the $3,000 will be nearly
30% of the loan amount. This increases the cost of your money
dramatically. Usually home equity or home improvement loans show a
higher disparity between note rate and APR because of this. Now,
with the same closing costs of $3,000 for a $100,000 loan, the
impact is equivalent to 3% of the loan.
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.
