Mortgage FAQ
10. What is an APR?
Annual Percentage Rate (APR) is an interest rate that is different from the note rate and is commonly used to
compare loan programs from different lenders. Mortgage companies are required by The Federal Truth in Lending
Law to disclose the APR when they are advertising a rate. The APR is usually found next to the rate.
The APR has
no effect on your monthly payments, which are a function of the interest rate
and the length of the loan.
The APR is a confusing number, even to mortgage bankers and brokers. The APR is designed to measure the "true cost
of a loan." It creates a level playing field for lenders by preventing other lenders from advertising a low rate
while hiding fees.
If things were simple, all you would have to do is compare APRs from the lenders/brokers you are working with
and pick the easiest one to find the right loan. Unfortunately, this is not the case.
Different lenders calculate APRs differently, so a loan with a lower APR is not necessarily a better rate. In this
author's opinion, the best way to compare loans is to ask each lender to provide you with a good-faith estimate of
their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Take each estimate and
ignore all of the fees that are independent of the loan such as homeowners insurance, title fees, escrow fees,
attorney fees, etc. Now add up all the remaining loan fees. The lender with 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, but companies may use any
number between 1 and 30, so pay attention to this number.
- Loan-processing fee
- Underwriting fee
- Document-preparation fee
- Private mortgage-insurance
The following fees are SOMETIMES included in the APR:
- Loan-application fee
- Credit life insurance (insurance that will pay 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
An APR does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock could
have a lower APR than a lender who offers you a 60-day rate lock.
Because future rates are unknown, calculating APRs on adjustable and balloon loans is even more complex.
This results in even more confusion over how lenders calculate APRs.
APRs for different types of loans cannot be compared. A 15-year loan might have a lower interest rate than
a 30-year loan, but it could also have a higher APR, since the loan fees are amortized over a shorter period of time.
Some lenders do not even know what they themselves include in their APR because they use software programs to
compute their APRs. This makes it possible that the same lender, with the same fees, using two different software
programs could arrive at two different APRs.
Conclusion:
The APR is a result of a complex calculation and not clearly defined, so only use it as a starting point to
compare loans. 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 when comparing loans.
