LETTERS From CAMP Rehoboth |
CAMP Money |
by Chris Beagle |
BTW, What's the APR?
Or should I say, by the way, what's the Annual Percentage Rate? In an age where the growing presence of acronyms is about as hard to miss as Rush Limbaugh's criticism of the President, LOL, it seemed a good opportunity to address one of the more confusing, and often misunderstood, aspects of financing. Over the last 12 years, I've explained APR hundreds of times. Since the explanation almost always conjures a perplexed and uncertain reaction, my usual follow-up is simply, "It's the real cost of financing." But what does that really mean? Some background will be helpful. APR was created in 1974 by the federal government as a consumer protection effort. The objective was to give borrowers a clear picture of the actual costs of the transaction, while providing consumers a method for comparing one mortgage offer against another, even when the rates, points, and costs differ. It required lenders to publish the Annual Percentage Rate for all regulated loans, mainly because the rate a lender charged didn't accurately reflect the "true" or actual cost of financing. The APR was also intended to inhibit lenders from hiding fees or upfront costs behind low interest rates in their advertising. Of note, when advertising any form of credit, the lender must ensure that the APR is more prominent than any other rate. As a borrower, when applying for financing, lenders are required to provide you a GFE (Good-Faith-Estimate) as well as a TIL (Truth-in-Lending Statement) within three business days of application. Both documents include an interest rate quote, but the TIL also includes the APR. Whether you're applying for a credit card or a mortgage, it is arguably the most important thing to consider. The tricky part is that it tends to confuse more than it reassures. Either way, you should know that the APR is not the interest rate you are paying on the loan, it doesn't determine the monthly payment, and it's always higher than the interest rate. Why? APR considers certain closing costs associated with the loan and spreads this total over the life of the loan (360 months for a 30 yr amortization). Those costs are subtracted from the loan amount being considered, resulting in a figure lower than the actual loan amount. Then the payment is calculated as if it were the payment on that lower amount, causing the APR to be higher than the note rate quoted. The only exception is when the lender pays all of your costs, often referred to as a "no-cost" loan. Insider tip, there really are "costs" associated with every loan. If you're being quoted a no-cost loan, the lender is just paying them for you by giving you a higher interest rate. To simplify, fees generally included in the APR calculation are Points, pre-paid interest, private mortgage insurance (if applicable) and loan processing, underwriting, document preparation, and application fees. Fees not normally included in the APR calculation include Title, Escrow, attorney, notary, home inspection, recording, transfer taxes, credit report and appraisal. Remember, not all lenders perform the calculation the same way and unless it's a fixed rate mortgage, APR is even more confusing. Calculating the APR on adjustable rate mortgages (ARMs) is more complex because there's no way of knowing what future rates will be, thus it may change during the duration of the loan. At this point, you just may be more confused than when you started reading. No worries, you're not alone. The mathematical formula for calculating APR is very complex and beyond the scope of this article. For now, suffice to say that understanding the concept is perhaps the best thing to remember, for its intentions are to serve the best interest of the consumer. When evaluating APRs, the most important factors to be considered are how long the loan is needed and what are the long-term goals of the borrower. If the buyer expects to stay in the home just a few years, it doesn't make sense to only consider a 30-year, fixed rate mortgage, simply because the APR seems more reasonable. Or, if a couple is buying a home, knowing they will refinance in several years to pay for their child's college education, then again, APR isn't a realistic factor to consider. A loan with a lower interest rate and higher points could easily have a higher APR than an interest rate quote at a higher rate with lower costs, but your "true cost" of borrowing may depend more on how long you keep the loan than anything else. Paying more in points to get a lower interest rate may save you more money if you intend to remain in the property for a long time, even though it has a higher APR. When looking for any loan, consumers should know that comparing the APRs of different products with different lenders is a good place to start. You should rely on the skills of a well-informed Loan Officer who can assist you in obtaining the loan that will best meet your specific needs.TTYL! Chris Beagle is a Senior Loan Officer at Fairway Independent Mortgage Corporation. For more information, contact Chris at 302-260-7090. |
LETTERS From CAMP Rehoboth, Vol. 19, No. 09 July 17, 2009 |