The federal government requires mortgage lenders to disclose the “annual percentage rate” (APR) whenever they advertise a loan program. But what is APR, and does it really matter to you? Here’s the thing: APR lumps all your “finance charges” into your interest rate. As you can see from the list below, some of your closing costs are considered “finance charges.” APR is calculated by adding all these finance charges to the total interest that you’ll pay over the life of the mortgage. An annual interest rate is then calculated based on that total number.
APR CLOSING COSTS & PREPAID ITEMS (FINANCE CHARGES):
- Origination Charges and Points
- Processing and Underwriting Fees
- Mortgage Insurance (monthly and upfront)
- Closing Agent Fees Retained by Mortgage Company, or Closing Fees in Excess of What You’d Be Charged if You Paid Cash
- Tax-related Service Fees Administrative and Wire Transfer Fees
- Pre-paid Interest
NON-APR CLOSING COSTS & PREPAID ITEMS:
- Application Fees
- Appraisal Fees
- Credit Report Fees
- Title Fees & Title Insurance
- Pest or Flood Hazard Inspection Fees
- Stamp and Transfer Taxes
- Pre-paid Escrows for Taxes and Insurance
Here are three little-known facts about APR:
#1 – ALL SELLER-PAID POINTS AND CLOSING COSTS ARE EXCLUDED FROM APR
This means that your APR will be lower if the seller is contributing funds toward your points and closing costs.
#2 – THE APR ON AN ADJUSTABLE RATE MORTGAGE (ARM) FOLLOWS A DIFFERENT FORMULA
When you have an ARM, the APR is calculated by looking at your “fully indexed rate”. This is the interest rate that you would pay if the loan adjusted today. For example, if you have a 5 or 7 year ARM, the APR on your loan is not calculated based on the rate you pay for the first 5 or 7 years of your loan. It’s based on what your interest rate would be in 5 or 7 years if the index remains the same as it is today. See Figure 2 for an example of a fully indexed rate.
#3 – THE APR DOES NOT TAKE INTO ACCOUNT HOW LONG YOU WILL KEEP THE MORTGAGE
Most people don’t keep the same mortgage for its entire term of 15 or 30 years. Chances are that you’ll probably refinance or sell your home at some point before the loan ends in 15 or 30 years. Therefore, when you compare your mortgage options, it’s probably smarter for you to look at what your total costs will be over 5, 7 or even 10 years vs. focusing entirely on comparing the APR. Remember, APR is simply one measurement of the cost of your loan… and it may not be the most accurate measurement for your purposes. I’d be happy to review your situation and help you compare your options. Contact me for more information!