APR

Annual Percentage Rate

What is the Real Cost of Financing?

Annual Percentage Rate (APR) is a tool that consumers use as a starting point to compare loan programs. However, it’s important to keep in mind that APR is not a perfect system, and not all lenders calculate APR in the same way. While the Federal Truth-in-Lending Act does require any mortgage broker or lender to disclose APR to the consumer, there is no rule written in stone for calculating this number that each and every lender agrees upon. The point of calculating APR is to let the consumer know what the actual cost of their financing is in the form of a yearly rate. Disclosing the cost of obtaining a mortgage loan by showing an interest rate that is based on factoring in the “Cost” of obtaining a loan. APR factors in certain closing costs and fees associated with the loan, and spreads this total over the life of the loan along with the actual note rate. The objective is to give the consumer a clearer picture of what their actual costs are in the form of a rate, this inhibits lenders from hiding fees or upfront costs behind low interest rates in their advertising. Fees that are generally included in the APR calculation are points, pre-paid interest, loan processing fees, underwriting fees, document preparation fees, and private mortgage insurance. On occasion, lenders will include a loan application fee and/or credit life insurance. Fees that are normally not included in the APR calculation are fees from Title, Escrow, attorney, notary, document preparation, home inspection, recording, transfer taxes, credit report and appraisal. Remember, all lenders do not perform the calculation the same way. Moreover, APR does not consider the possibility of making pre-payments, moving or refinancing. Unless the interest rate is tied to a fixed instrument, APR is even more confusing. Calculating APRs on adjustable rate and balloon mortgages is more complex because we really have no way of knowing what future rates will be. If all lenders calculated APR the same way, we could make easy comparisons when deciding on what loan program to go with. Since they don’t, the consumer should know that APR is simply a starting point for comparison. The consumer should rely on the skills of a well-versed loan professional to assist them in obtaining the loan that meets their specific needs. The more important things to consider are how long the loan is needed, how long do they plan on living in the home. What are the long-term goals of the borrower? If the home buyer only expects to stay in the home for five years, there is little sense in looking exclusively at 30-Year Fixed rates because the APR seems more reasonable. If a young couple is buying a home, knowing they will refinance in eight years to pay for their son’s college education, then once again, APR is not a realistic factor to take into consideration. This applies to refinancing, as the borrower who is currently paying a 5.75% rate but had a 20 year loan with only 16 years left, should he finance closing cost to obtain a 4.5 % rate 15 year loan? The answer is a clear no; without financing closing cost he would still pay more over the life of the 15 year loan.