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.A.P.R. stands for Annual Percentage
Rate. It is also one of the most misunderstood numbers when people apply
for loans. |
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As consumer loans, and mortgages in
particular, became more complicated, it became necessary to help
regulate the way lenders advertise and notify the potential borrower of
their interest rates. The attempt is to help people compare similar
loans from different lenders and to explain the ultimate cost of credit.
The A.P.R. is defined as the cost of credit to the borrower in relation
to the amount borrowed expressed as a yearly rate. This is required by
the Federal Truth in Lending Act, Regulation Z.
When you apply for a mortgage, you will be sent the
Federal Truth in Lending Disclosure form. At the top of the page, you
will see lots of numbers. Two of these numbers are the Note Rate (the
actual rate used to calculate your monthly payments) and the Annual
Percentage Rate (A.P.R.). The Annual Percentage Rate will most always be
slightly higher than the note rate because the A.P.R includes other
items associated with obtaining a mortgage.
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Do you need an interest rate to get a mortgage? Of
course, but you also need other things. Origination fees, points,
mortgage insurance premiums, inspections, prepaid interest and other
items may also be required to obtain a mortgage. If so, these things
need to be included when calculating the A.P.R. Why is the A.P.R useful
? I'll give you an example: Great Big Bank offers a 30 year fixed
mortgage for 8.00%. Really Small Bank offers a 30 year fixed mortgage
for 7.00%. Easy choice, right? Maybe. Before lenders and mortgage
brokers were required to state the A.P.R., it was hard to tell. Really
Small Bank has the lowest rate (note rate) but neglected to mention a
few other items. There were also 7 points, an origination fee and
mortgage insurance required. Great Big Bank has no points, no
origination and just prepaid interest (your first months house payment).
On a $100,000 loan, Really Small Bank charges an additional $10,000 when
compared to Great Big Bank's fixed rate loan. You can save an additional
sixty-eight dollars per month with Really Small Bank's mortgage, but you
have to pay $10,000 for the privilege. The $10,000 must be included as a
cost to obtain the mortgage. |
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Here's another example: Mr. and Mrs. Smart want to buy
an $85,000 home. The developer of the project they really like has a
home and offers an interest rate similar to what they could get at the
mortgage company. The developer offers 6.00% fixed with no points. The
mortgage company also quotes 6.00% with no points but has an origination
fee equal to 1 percent of the loan amount.
BUT WAIT! The Developer failed to disclose there is a
2 percent origination fee ! What looked like a better deal at the
developer's lender turned out to be higher. If the A.P.R.'s were given,
it would be evident.
In this instance, the A.P.R. for the developer would
be 6.189% and the mortgage company's A.P.R calculates to 6.094% due to
the higher fees charged by the developer. Even though the note rate (the
rate used to figure monthly payments) was the same, it cost more at the
developer. Therefore, Mr. and Mrs. Smart (the name is more than just a
coincidence) chose the mortgage from The mortgage company.
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Remember, the higher the loan amount, the less impact
additional fees or points will have on the A.P.R. Why ? If you obtain a
mortgage with $2,000 of closing costs and you borrow $10,000, then the
$2,000 will be nearly 20% of the loan amount. This increases the cost of
your money dramatically. Usually home equity or home improvement loans
show a higher disparity between note rate and A.P.R. because of this.
Likewise, if you borrow $100,000 and have $2,000 of closing costs, the
fees won't make as significant an impact on the cost of funds.
But what about the fees used to calculate the A.P.R. ?
Are there some fees that are excluded from the calculation ? As a
general rule, any fees that are normally used in connection with
financing should be included in the A.P.R. Other fees, such as title
insurance and escrow fees, are not included in calculating the A.P.R.
The idea here is these other fees are not coming from the lender, and
they would be charged anyway, although in the real world, this also may
not be true. When you compare A.P.R.s, ask the lender which additional
fees are included when calculating their A.P.R. If they don't know the
answer, you may want to find a lender that does know. A.P.R.s are a way
of helping the consumer determine the best loan.
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