What is Mortgage APR, Can You Explain It?

By
Real Estate Mortgage Broker NMLS 291249
http://actvra.in/PYC

WHAT IS MORTGAGE APR, Can You Explain It?

APR Demystified

First, lets demystify the calculation for Annual Percentage Rate (APR).

Mortgage APR was designed to allow consumers to use one standardized number to compare each lender's rate for the same type of loan while rate shopping.  It is supposed to represent the borrower's cost and it works like this.

If I lend you, $10,000  and, I charge a $500 Bump-ta-Bump Fee, you will actually receive $9,500, however you must still repay me Mortgage APR$10,000.  Mortgage APR is my real yield and your real cost on this loan.

We agreed that you will repay the loan at 8% interest on $10,000, HOWEVER you only received $9,500 therefore I will earn more than the 8.0% interest rate I charge on $10,000.  In this case, my yield (APR) is 9.799% on the $9,500 you actually received.   

APR is the lender's yield on dollars actually lent ($10,000 minus $500 = $9,500); in this case, the lender's yield (APR) on $9,500 is 9.799%   (APR is computed as if the above example is a 30 year loan)

The $9,500 also represents the Amount Financed in the Truth In Lending (TIL) disclosure. 

For those of you who use spreadsheets the Rate Function will find APR.  Use the Amount Financed for Loan Amount and use the monthly payment on the actual loan amount.

Fees that must be subtracted from a mortgage loan to properly calculate Amount Financed for APR

  • Origination and Discount Points
  • Processing and Lender Fees
  • Pre-Paid Interest (Use 15 days when closing date is unknown)
  • Monthly Mortgage Insurance must be added to the payment of all FHA loans and Conventional loans greater than 80% loan to value. 
  • The inclusion of Mi or MIP accounts for the large spread between Rate and APR on loans with mortgage insurance.

 

NOTES:  FeesNot used in APR calculation; third party fees such as appraisal and credit.  APR can only be compared on loans of the same type and amortization period

How Do APR Predators Work?Mortgage APR Predator

Many sophisticated borrowers shop interest rates by searching for lowest APR which, if property stated, is a valid way to compare similar loans.  Unfortunately, APR is not always stated properly.

How is advertised Mortgage APR is misstated? 

  • Prepaid Interest is not included - most common deception and true on all online Rate sites   i.e.: Bankrate.com, Interest.com, Mortgage101.com, ShopRate.com, etc.
  • Prepaid Interest is understated - must be 15 days when closing date is unknown.
  • MI or MIP is not included in the APR on any online rate sites, Bankrate etc.
  • Some lenders do not include MI or MIP on their web sites such as Amerisave.com 
  • Lender fees are either understated or not included in the APR calculation.  This is a tricky one because No or Low Lender Fees does not necessarily indicate a predatory lender.  Some lenders charge a higher rate and no points or fees for their so called "Zero Cost" loan.  However, the "Zero Cost" rate will always be higher than a rate with points and/or fees. 
  • Notes to the above: 
    • there is no such thing as a Zero Cost loan and some states prohibit lenders from advertising Zero Cost Loans.
    • The spread between Rate and APR on loans greater than 90% LTV should be at least 0.700%.  When it is not... you are being scammed

Rate - Points - Fees are all interdependent

The best way I can explain this is show various Rate - Point - Fee combinations where the lender is making the same gross profit on each combination

In the examples below, we will use a $200,000 loan amount and Lender gross profit of $1,000, on a day when the Lender's cost for a 5.000% rate is par (0 point).

Best Rate:  $1,000 Lender profit in various combinations of points and fees

Rate

Fees

Points

APR

Profit

5.000%

$1,000

     0   

5.044%

$1,000

5.000%

$500

 0.250

5.044%

$1,000

5.000%

$0

 0.500

5.044%

$1,000

Lowest Fees:
Increase the rate to 5.125% and you pay $0 points and fees and Lender's investor pays the lender $1,000 for the higher rate.  

Rate

Fees

Points

APR

Profit

5.125%

$0

    0   

5.125%

$1,000

The point here is that lenders design their loans to provide talking points for their sales staff (loan officers).  They all require a certain profit margin and it is not important the way the loan is structured as long as the closed loan delivers their required profit margin. 

This illustration also points out the value of correctly stated APR as a way of comparing mortgage loans.  For the sake of these illustrations, prepaid interest was not used.  If 15 days PP was calculated it would have increased each APR by 0.019%.

close

Re-Bloggged 36 times:

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Topic:
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Comments 189 New Comment

Anonymous
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Rainmaker
929,064
Gary L. Waters, Broker Owner Waters Realty of Brevard, LLC
Personal Service, always.
Waters Realty of Brevard, LLC

I am not sure many consumers understand the difference between interest rate and APR.

April 07, 2013 04:43 PM
Rainmaker
570,609
Bill Ladewig
Your FHA Guru - FHA and VA Loans Since 1970

Thanks all for your comments.

Charles, thank you, a simple mind is able to state things simply.

Joan, there is a lesson here about politicians doing most things.

Fred, Kind of what I said to Joan.  Politicians can even screw up a good idea.

John, thanks. The good news is that we can never know too much.

Wika, I enjoyed that you read my post.

Randy, a good man with a HP12C can rule the world.

Gary, you are correct and that causes problems for those cannot explain the difference.

April 08, 2013 02:37 PM
Rainmaker
971,016
Sharon Alters
Your Fleming Island Relocation Agents.
Coldwell Banker Vanguard Realty

Bill, I have a more complete understanding of APR thanks to your very thorough explanation. Deducting the fees from the amount borrowed and calculating the interest on that amount - now I understand it!! And the example of how the lender can arrive at the same gross profit depending on what the borrower can stand or is willing to pay is very helpful. Thanks!! Sharon

June 26, 2013 07:12 PM
Rainmaker
1,112,078
Richie Alan Naggar Author PEARLS SERIES of books
on LIFE and LOVE plus Real Estate too!
People first then business! Ran Right Realty Riverside, Ca

The first time I tried to explain this many years ago, I taught myself a lessen in GIBBERISH...In other words, I dint know and wouldn't admit. Today I have enough sense to say, that is a good question ask a loan officer

June 27, 2013 07:14 AM
Rainmaker
570,609
Bill Ladewig
Your FHA Guru - FHA and VA Loans Since 1970

Hi Sharon, I am pleased the article helped.  Thanks for your comment.  

Hi Richie.  It is a shame that APR is so confusing.  You are right, it is a good question for loan officers.

June 27, 2013 07:25 AM
Anonymous
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Rainmaker
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Bill Ladewig

Your FHA Guru - FHA and VA Loans Since 1970
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