WHAT IS AN ANNUAL
PERCENTAGE RATE (APR) ?
The annual percentage
rate (APR) is an interest rate that is different from
the note rate. It is commonly used to compare loan programs
from different lenders. The Federal Truth in Lending
law requires mortgage companies to disclose the APR
when they advertise a rate. Typically the APR is found
next to the rate.
fixed 8% 1 point
The APR does NOT affect
your monthly payments. Your monthly payments are a function
of the interest rate and the length of the loan.
The APR is a very confusing
number! Even mortgage bankers and brokers admit it is
confusing. The APR is designed to measure the "true
cost of a loan." It attempts to create a level
playing field for all lenders. It prevents lenders from
advertising a low rate and hiding fees.
If life were easy, all
you would have to do is compare APRs from the lenders/brokers
you are working with, then pick the easiest one and
you would have the right loan. Right? Wrong!
lenders calculate APRs differently. So a loan with a
lower APR is not necessarily a better rate. The best
way to compare loans in our opinion is to ask lenders
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. Then delete all fees that are
independent of the loan such as homeowners insurance,
title fees, escrow fees, attorney fees, etc. Now add
up all the loan fees. The lender that has lower loan
fees has a cheaper loan than the lender with higher
loan fees (assuming the lender is fully disclosing all
of the fees you will pay at closing).
The reason why APRs are
confusing is because the rules to compute APR are not
An APR does not tell
you how long your rate is locked for. A lender who offers
you a 10-day rate lock may have a lower APR than a lender
who offers you a 60-day rate lock!
Calculating APRs on adjustable
and balloon loans is even more complex because future
rates are unknown. The result is even more confusion
about how lenders calculate APRs.
Do not attempt to compare
a 30-year loan with a 15-year loan using their respective
APRs. A 15-year loan may have a lower interest rate,
but could have a higher APR, since the loan fees are
amortized over a shorter period of time.
Finally, many lenders
do not even know what they include in their APR because
they use software programs to compute their APRs. It
is quite possible that the same lender with the same
fees using two different software programs may arrive
at two different APRs!
In conclusion, use the
APR as a starting point to compare loans. The APR is
a result of a complex calculation and not clearly defined.
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 lender (title
fees, appraisal, taxes and insurance, etc.)