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:
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.
