Friday, June 22, 2012 - Article by: Joseph Jesuele - Liberty Financial Associates -
For residential mortgages, disclosure of the annual percentage rate (APR) is very important. The APR tells a borrower the total cost of financing a loan in percentage terms, as a relationship of the total finance charges to the total amount financed. Finance charges are more than just interest. They include any point required by the lender for any reason, loan origination fees, etc. When the buyer must pay points and a loan fee, the APR will be higher than just the interest rate. For example, a mortgage loan with an 11% interest rate may have an APR of 11.5%, representing the total cost of the loan, including all finance charges spread over the life of the loan. And even though different interest rates may apply during the loan term (e.g. with adjustable rate mortgages), the loan still has only one APR.
Most borrowers are confused by this apparent contradiction, particularly when they think they are getting a fixed rate loan at a particular interest rate. They often expect that the interest rate they received for the loan, or the note rate, reflects the total cost of borrowing money. It is helpful at this point for the mortgage banker or loan officer to explain that the APR includes not just the interest rate on the note, but the total cost of the loan, including all other finance charges spread out over the life of the loan. Not all closing costs are calculated into the APR. The Good Faith Estimate of closing costs will indicate which costs are calculated into the APR. As a general rule to assist in understanding what costs are included and which ones are not, consider the following example. If a borrower was purchasing a home for cash, there would be certain closing costs that he or she would not incur, such as an application fee, credit report fee, underwriting fee, mortgage insurance, and interest on their loan. These are generally the same costs that are included in the APR calculation. Other closing costs such as transfer tax and a notary fee are costs that a buyer incurs even if they are not financing a portion of their home. Therefore, these costs would not be part of the APR calculation.
The APR is a useful tool to help borrowers compare a loan program from one lender to another. Borrowers should always ask lenders what the APR is when they are shopping around for the best deal. In fact, federal law requires lenders to disclose the APR whenever they quote an interest rate to a consumer, whether orally or in writing. If a borrower contacts one lender and is offered a rate of 5.25% with a 5.89% APR and a second lender offers a rate of 5.50% with a 5.75% APR, then the borrower should strongly consider the second offer since the total cost of the loan is lower. Of course, applicants should always get multiple offers from different lenders or work with a licensed mortgage broker to find the best deal for their specific situation.
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