What is APR?
Annual Percentage Rate (APR) is a tool consumers use as a starting point to compare loan programs and lenders. The point of the APR is to let consumers know their actual costs in a yearly rate when the actual note rate, certain closing costs and fees required to obtain a loan are factored in and spread over the life of the loan. Calculating the APR is meant to give consumers a more accurate picture of their actual costs and to prevent lenders from hiding fees or upfront costs behind a low interest rate they may be advertising.
Is There a Formula for Calculating APR?
Although the Federal Truth-in-Lending Act does require a mortgage broker or mortgage banker disclose the APR to the consumer, strict rules have not been put in place to determine how the APR is calculated. Consequently, the APR should be used as a starting point for comparison and consumers should rely on the skills of a knowledgeable mortgage advisor to help them determine which programs meet their specific needs.
Fees Generally Included in the APR Calculation
The fees generally included in the Annual Percentage Rate calculation are:
- Points
- Pre-paid interest
- Loan processing fees
- Underwriting fees
- Loan document preparation fees
- Private mortgage insurance
Fees Sometimes Included
The fees sometimes included in the calculation of the Annual Percentage Rate are:
- Loan application fee
- Credit life insurance
Fees Normally Not Included
The fees normally not included in the calculation of the Annual Percentage Rate are:
- Fees from Title and Escrow
- Attorney Fees
- Notary Fees
- Document Preparation
- Home Inspection Fees
- Recording Fees
- Transfer Taxes
- Credit Reporting Fee
- Appraisal Fee
What APR Does Not Take Into Consideration
As we mentioned, all lenders do not calculate APR in the same way. APR also does not consider any pre-payments, paying off the loan early or refinancing the loan. If you are in an adjustable rate mortgage (ARM) or a balloon mortgage, the calculated APR is even less helpful because it is impossible to predict what mortgage interest rates will be when your interest rate adjusts.
How Can Consumers Measure Cost of the Loan?
In a perfect world, all lenders would calculate APR the same way and consumers would have a better understanding of the cost of a loan. But, because this is not the case, consumers need to use APR as a starting point to compare lenders and find a mortgage advisor they trust and that can offer them a menu of loan options that suits their needs. Some questions a qualified loan officer will ask are…
- How long will the loan be needed?
- What are your short and long term financial goals?
- How long do you plan to be in the home?
- Do you have plans that could cause you to make a life change (i.e. cash out to pay for child’s college or major home improvements)?
When APR is Not as Realistic a Measure
Because APR does not factor in paying off the loan early, refinancing or moving, it is even more important you have a qualified mortgage professional who will ask you questions about your financial goals and match you with a loan program that meets your specific financial goals. The most important consideration for which program you select has to do with how long you plan to have the loan. If you are planning to refinance the home in 10 years to pay for a child’s college tuition, or you are only planning on staying in the house for 5 years, the APR becomes less and less important. Also, keep in mind, most people refinance their homes when rates drop, which is essentially paying off a loan early.
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Chris Williamson is a Mortgage Advisor with Mortgage California specializing in San Mateo Mortgage.
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