Fred Griffin: What is Mortgage APR? Can You Explain It?

What is Mortgage APR? Can You Explain It?

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; it works like this:

___________________________

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:  FeesNot 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:
Increase the rate to 5.125% and 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%.

 

Frederick Griffin, Licensed Florida Real Estate Broker    850-545-1901

 

Tallahassee Florida Metropolitan Area

and the Coastal communities of

Shell Point Beach, Live Oak Island, Wakulla Beach, Saint Marks, Panacea

 

Exclusive Representation for Buyers and Sellers 

Call Fred  850-545-1901

 

 Realtor logo       HUD Logo Fair Housing

 

 

Frederick Griffin, Licensed Florida Real Estate Broker    850-545-1901

 

Disclaimer:  Nothing in the above blog article is to be construed as legal advice, tax advice, or financial advice.  For legal advice see an attorney.   For tax advice or financial advice see a tax attorney, certified public accountant, or other qualified professional.

 

Comment balloon 4 commentsFred Griffin • April 07 2013 04:39PM

Comments

I am not sure many consumers understand the difference between interest rate and APR.

Posted by Gary L. Waters, Broker Owner, Waters Realty of Brevard, LLC, ... a small office, delivering big service! (Waters Realty of Brevard, LLC) over 4 years ago

The lender is required to provide borrower an APR sheet at the time of signing loan documents. By that time, borrowers are just happy to be getting a loan and buying their new home. It's doubtful lenders go over APR before that time.  

Posted by Pamela Seley, Residential Real Estate Agent serving SW RivCo CA (West Coast Realty Division) over 4 years ago

This is a very informative blog on mortgages & how to know what an APR is. Great blog designed for the first time buyer if that is possbile. Great Job!

Posted by Jimmy Faulkner, The Best Of St. Augustine (Florida. Homes Realty & Mortgage) over 4 years ago

Gary - very few of them understand it!

 

Pamela - they hear it one last time at Closing, their eyes glaze over and they sign the papers.

 

Jimmy - thanks goes to Original Blog Author Bill Ladewig!

 

Posted by Fred Griffin, Licensed Florida Real Estate Broker (Fred Griffin Real Estate) over 4 years ago

Participate