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What They Don't Want You to Know
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What They Don't Want You to Know
By
1st Mortgages
The annual percentage rates (APR) is mandated
by the Congress of the United States to be given us, the borrowers,
in our disclosure documents prior to and upon closing of a mortgage
loan. Yet, even the most astute mortgage professionals have only
a cursory knowledge of this important measuring device. The industry,
as a whole, knows little about how the mathematics of this measure
actually works or how a higher interest rate with less in fees could
actually be the better loan.
Why Ask?
The first question that should be asked of a lending source, whether
you are dealing with a mortgage broker or a mortgage lender, should
be "What is the annual percentage rate?" and not "What
is the interest rate".
Cost Disclosure
Let's discuss what APR was meant to disclose and how it should be
used. Let's start with a hypothetical mortgage of a 7.00% - 30 year
mortgage of $100,000 that has an origination fee (commission) of
1&1/2 points (1&1/2% of the loan amount or in this example
$1,500) and other fees of $2,500. Sound pretty good? The APR is
7.409%. What happened to the 7.00%?
Mortgage Math
You are paying $4,000 to borrow $100,000. In effect you are only
getting $96,000, but will pay back the full $100,000 with interest.
Another way to look at understanding the annual
percentage rate is: The $4,000 of fees in the above example divided
by 30 years is $133.33 per year of additional interest. What happens
if we pay this loan off in 5 years? The APR jumps to 7.998%. The
fees we pay are spread over fewer years, increasing the costs per
year. The $4,000 in fees divided by 5 years sky rockets to $800
per year of additional interest.
See if you can guess which is the lowest
cost loan:
Example # 1 - 30 year fixed rate loan at 6.875%
with 2 & 1/2 points origination fee and additional fees of
$2,443
Example # 2 - 30 year fixed rate loan at 7.000% with 2 points
and additional fees of $1,943
Example # 3 - 30 year fixed rate loan at 7.125% with 1 & 1/2
points and additional fees of $2,143
The correct answer is Example # 1 with an
APR of 7.381%. Example # 2 and Example # 2 had APRs of 7.403
and 7.500 respectively.
Now let's apply some reality to the above examples.
Fewer than 5% of all 30 year mortgages are kept 30 years. What if
this loan is paid off in 5 years?
Give up? Example # 2 with an APR of 7.984% #1
had an APR of 8.113% and #3 8.035.
When you next shop for a mortgage, what is the first question you
should ask? And if THEY can't answer, before hanging up, tell THEM
that "the APR is the measure of all of the costs of a mortgage
expressed as an annual percentage rate".
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