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What is APR on Mortgage Interest? Deceiving!

Most home owners and home buyers have no idea what APR (Annual Percentage Rate) is. I know this because of the over 3000 borrowers I have dealt with a very large percentage have questioned it. Oddly enough most loan officers don’t fully understand APR and those who do often understand it just enough to manipulate it to make theirs look lower than someone else’s.

The APR has been a major part of the home buying process since 1974 when the current Truth In Lending (TIL) form was introduced as a result of the Truth In Lending Act (TILA). It was “supposed” to give shoppers a level shopping ground for comparing rates and closing costs. All it did in actuality is allow savvy salesmen to manipulate yet another number to confuse the borrowing public.

What the APR is supposed to be is the base interest rate plus the cost of closing calculated as a percent of the loan and spread over the life of the loan. In other words if your closing costs are $5000 on a $100,000 loan that would be 5% divided by 12 months (annualized)? would be .416% so add that to the original interest rate of 5% and now your APR should be 5.16% – sounds simple, right?

Where it gets complicated is when you start comparing different types of loans, different ways of calculating closing costs, who is paying closing costs, whether there are discount points, etc. For example on that same loan the loan officer may be showing the seller paying some or all of the closing costs so they don’t become an actual part of the buyer’s repayment. Would that make the APR 0% – technically it would. However since all fees still must be disclosed it does not. The procedure is flawed and it’s not the worst way to shop for a mortgage but it’s close.

The MOST important things about a mortgage are the following:

1. Down Payment – how much equity participation are you establishing in the beginning?
2. Loan Amount – what is the actual amount borrowed?
3. Terms of the Loan – is it fixed or adjustable? When is it due? How many payments are to be made?
4. Total of Payments – if you pay the loan off full term how much will you repay?
5. Monthly Payment (Principal and Interest) – this is where the rubber meets the road.

Closing costs and discount points can be manipulated and disguised. Interest rates can be adjustable and that’s tricky unless you understand floor, index, margin, cap, and period. That’s an entirely different post in itself. Furthermore not all “costs paid at closing” are a part of the APR. In fact unless the fee is a direct result of the loan finance it is not a part of the APR. That’s where I’ve seen a lot of TIL forms not properly completed – especially by some of the bigger lenders and banks.

If I were shopping for a mortgage today I would not look at the annual percentage rate as much as the 5 items listed above. If I like all of them and they are better than what another lender offered then I would take it.

Try this simple Excel file [download]