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!
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?
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
You pay $0 points and fees and Lender's investor pays the lender $1,000 for the higher rate.
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%.
Education is Consumer's Only Real Protection.
Listed below are some educational articles.
- What You Should Know About APR
- How To Shop for Mortgage Rates.
- Beware of Misleading Lender Advertising
- Education is the best consumer protection
- Rates and Point Relationship Explained
Bill Ladewig is a Mortgage Broker Licensed by the California Department of Real Estate 00968137