What is Mortgage APR, Can You Explain It?

Reblogger
Mortgage and Lending with PEOPLES MORTGAGE CO. AZBK 0904164 NMLS 6274 AZLO 0915719 NMLS 216866

I have been receiving Bill's newsletter daily and have learned tons from this man and his experience. Occasionally I will share some of his more interesting blogs. This one is a little technical, but a great explanation none the less. Enjoy!

Original content by Bill Ladewig NMLS 291249

WHAT IS MORTGAGE APR, Can You Explain It?

APR Demystified and APR Predators Exposed

First, lets demystify Annual Percentage Rate (APR).

Mortgage APR was designed to allow consumers to use one standardized number to compare each lender's rate for the same type of loan while rate shopping.  It is supposed to represent the borrower's cost 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.  Mortgage 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 earn 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%   (APR is computed as if the above example is a 30 year loan)

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.
  • NOTES:  Fees Not used in APR calculation; third party fees such as appraisal and credit.  APR can only be compared on loans of the same type and amortization period

    How Do APR Predators Work?APR Predator

    Many sophisticated borrowers shop interest rates by searching for lowest APR which, if property stated, is a valid way to compare similar loans.  Unfortunately, APR is not always stated properly.

    How is advertised Mortgage 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 0.700%.  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 required profit margin. 

    This illustration also points out the value of correctly stated APR as a way of comparing mortgage loans.  For the sake of these illustrations, prepaid interest was not used.  If 15 days PP was calculated it would have increased each APR by 0.019%.

    Comments (5)

    Brian & Val Mayer
    RE/Max One | Sellers Agent - Huntingtown, MD
    Listing Specialist | Realtor in Calvert County MD

    There are a lot of games that can be played and a lot of ways to spin things. I believe that straight talk and a quick reminder that "this is America" and I need to feed my family as well keeps everything on the table in a way that people understand.

    Jan 08, 2010 01:05 AM
    Anonymous
    Anonymous

    Great info.....now included in my buyers info.

    Jan 08, 2010 01:12 AM
    #2
    Diane Osowiecki
    Diane O and Friends - Benchmark Realty - Franklin, TN
    Greater Nashville Real Estate

    Timely info with the new regulations.  Great info for buyers who are now encouraged to "shop around."

    Jan 08, 2010 01:23 AM
    Mike Jones
    SUNSTREET MORTGAGE, LLC (BK-0907366, NMLS 145171) - Tucson, AZ
    Mike Jones NMLS 223495

    Lori,

    Now if only someone could demystify the new GFE...  LOL

    Mike in Tucson

    Jan 09, 2010 02:08 PM
    Lori Martinez Equal Housing Lender
    PEOPLES MORTGAGE CO. AZBK 0904164 NMLS 6274 - Prescott, AZ
    Personal Mortgage Professional

    Thanks for the comments Brian and Diane.

    Mike, yes the GFE is yet the next new challenge! Good in some ways but so lengthy!! Is that all really needed? I was out looking at cameras this weekend. I remembered the advice you gave me at the AR seminar I met you at.  :)

    Jan 11, 2010 04:47 AM