What is an Annual Percentage Rate (APR)?

Posted under Credit / Your Fico Score, Mortgage Purchase Loans, Mortgage Refinance

Betcha didn’t know this. The annual percentage rate (APR) is different from the note rate. Period.

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 commonly used to compare loan programs from different lenders.
It is designed to measure the ‘true cost of a loan.”

The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate.
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.

What I suggest is to ask the different lenders you’re calling on to provide you with a good-faith estimate of their costs of the same type of loan program eg 30-yr fixed with a 30-yr fixed rate 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, Admin fees, Appraisal, credit report 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:

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

PLEASE NOTE!
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.

Conclusion :
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.

Written by Holly Leano - REALTOR and Sr Mortgage Consultant

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