OMG Watch Out for Lurking APR Predators
APR Predators and APR Demystified
First, lets demystify Annual Percentage Rate (APR).
APR was designed to allow consumers to use one standardized number to compare the real cost of each lender's interest rate and it works like this.
If I lend you, $10,000 and, I charge a $500 Bump-ta-Bump Fee, you will actually receive $9,500, however you must still repay me $10,000. APR is my real yield and your real cost on this loan.
We agreed that you will repay the loan at 8% interest on $10,000, HOWEVER you only received $9,500 therefore I will yield more than the 8.0% interest rate I charge on $10,000. In this case, my yield (APR) is 9.799% on the $9,500 you received.
APR is the lender's yield on dollars actually lent ($10,000 minus $500 = $9,500); in this case, the lender's yield (APR) on $9,500 is 9.799%
The $9,500 also represents the Amount Financed in the Truth In Lending (TIL) disclosure.
For those of you who use spreadsheets the Rate Function will find APR. Use the Amount Financed for Loan Amount and use the monthly payment on the actual loan amount.
Fees that must be subtracted from a mortgage loan to properly calculate Amount Financed for APR
Origination and Discount Points Processing and Lender Fees Pre-Paid Interest (Use 15 days when closing date is unknown) Monthly Mortgage Insurance must be added to the payment of all FHA loans and Conventional loans greater than 80% loan to value. The inclusion of Mi or MIP accounts for the large spread between Rate and APR on loans with mortgage insurance. Note: Fees Not used in APR calculation; third party fees such as appraisal and credit.
How Do APR Predators Work?
Many sophisticated borrowers shop interest rates by searching for lowest APR which, if property stated, is the real cost of borrowing. Unfortunately, APR is not always stated properly.
How is advertised APR is misstated?
- Prepaid Interest is not included - most common deception and true on all online Rate sites i.e.: Bankrate.com, Interest.com, Mortgage101.com, ShopRate.com, etc.
- Prepaid Interest is understated - must be 15 days when closing date is unknown.
- MI or MIP is not included in the APR on any online rate sites, Bankrate etc.
- Some lenders do not include MI or MIP on their web sites such as Amerisave.com
- Lender fees are either understated or not included in the APR calculation. This is a tricky one because No or Low Lender Fees does not necessarily indicate a predatory lender. Some lenders charge a higher rate and no points or fees for their so called "Zero Cost" loan. However, the "Zero Cost" rate will always be higher than a rate with points and/or fees.
- Notes to the above:
- there is no such thing as a Zero Cost loan and some states prohibit lenders from advertising Zero Cost Loans.
- The spread between Rate and APR on loans greater than 90% LTV should be at least 0.800%. When it is not... you are being scammed
Rate - Points - Fees are all interdependent
The best way I can explain this is show various Rate - Point - Fee combinations where the lender is making the same gross profit on each combination.
In the examples below, we will use a $200,000 loan amount and Lender gross profit of $1,000, on a day when the Lender's cost for a 5.000% rate is par (0 point).
Best Rate: $1,000 Lender profit in various combinations of points and fees
Rate
Fees
Points
APR
Profit
5.000%
$1,000
0
5.044%
$1,000
5.000%
$500
0.250
5.044%
$1,000
5.000%
$0
0.500
5.044%
$1,000
Lowest Fees: You pay $0 points and fees and Lender's investor pays the lender $1,000 for the higher rate.
Rate
Fees
Points
APR
Profit
5.125%
$0
0
5.125%
$1,000
The point here is that lenders design their loans to provide talking points for their sales staff (loan officers). They all require a certain profit margin and it is not important the way the loan is structured as long as the closed loan delivers their margin.
This illustration also points out the value of correctly stated APR as a way of evaluating the true cost of a mortgage loan. For sake of these illustrations, prepaid interest was not used. If 15 days PP was calculated it would have increased each APR by 0.019%.
Bill Ladewig, Your FHA Guru (and APR)
800.664.7283 (SAVE)
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