In actuality there is only one INTEREST RATE on every mortgage. This rate of interest can be found on your mortgage note and should not be confused with the ANNUAL PERCENTAGE RATE. The INTEREST RATE is used to calculate your monthly payment using the loan amount and the loan term. The ANNUAL PERCENTAGE RATE is disclosed on the Truth In Lending Disclosure (aka the Federal Confusion Form). This ‘yield’ rate takes into consideration certain applicable closing costs in conjunction with your loan terms to formulate said APR. Generally speaking you’d like to have the APR as close as possible to the interest rate. There are state and federal guidelines in place to protect consumers from high cost mortgage loans and the APR is one of the determining factors. You will notice other discrepancies contained on the Truth In Lending Disclosure such as loan amount (lower than your actual loan amount contained on the note). I hope this clears the air for you!
APR is a mystery to most borrowers and probably the biggest headache for most originators to explain. When I first got into the business 8 years ago it took me a while to understand it and even longer to figure out a good way to explain it.
APR is the true “cost” of the loan including all the fees, prepaid interest, etc. financed in the loan. If you were to pay ALL of the fees/expenses of the loan out of pocket, then the APR would match your NOTE rate.
APR is probably the most confusing thing when it comes to disclosures on a loan. But it is a very effective way of comparing 2 different loans with the same NOTE rate. I hope this helped.
There is a note rate and there is an annual percentage rate or APR. Payments are based on the note rate. The APR is a disclosure given to you under the Truth In Lending Act, sometimes called Regulation Z, that gives you an effective rate of interest over the life of the loan when certain closing costs are factored in. This is like the unit pricing in the supermarket which tells you what the better deal is on boxes of cereal simply put.
However, there are certain assumptions made. The first is that you will pay 360 payments on your 30 year loan without selling the house, refinancing the house or making additional pre-payments to principal. The second one is that all APRs simplify the understanding of comparison shopping. The basic idea is that a mortgage with a rate of 5% with no points is hard to compare with a mortgage with a rate of 4.5% with 2 points without some type of tool to give you a fair comparison point. Any advertisement that promotes a rate, and violators are many, MUST contain the APR along with the other components found on a Truth In Lending Disclosure. Amount Financed [not the same as the loan amount, but a net figure after backing off pre-paid finance charges], Total Finance Charge, Schedule of Payments and Total Amount Paid must appear in the ad as well.
For example, a $100,000 loan with no points at 5% would carry a payment of $536.75 and if there were no pre-paid items that would be considered finance charges, the APR would be the same as the note rate. This almost never happens. That same loan at 4.5% with 2 points would carry a payment of $506.60. But it would cost $2000 [the 2 points] to get that rate and payment. The Amount Financed would in essence be only $98,000 because you paid $2,000 to get the loan of $100,000. An approximation of APRs would be to add 1/8% to the note rate for every point paid. So, in this example, the APR would be around 4.75%.
But, it isn’t always about the rate. Another lender may be touting a 4.25% rate, but might be charging a $500 processing fee and a $400 underwriting fee AND 3 points PLUS an origination fee of 1% or another $1000. Which is the better deal? It would appear that the 4.5% with 2 points would be better. This is why APR should not be the only thing you look at while shopping. It is a tool, but without a Good Faith Estimate of Settlement Charges, it does not tell you the whole story.
The NOTE Rate and APR are meant to be a tool to compare loans with very differing figures or offerings which make it otherwise hard to compare. But you still cannot go for the lowest APR all the time and be making the best decision. A High cost loan to buydown the NOTE Rate will result in a lower overall APR; however you may sell in 10yrs and lose money by taking the lower APR deal :) Get a trusted advisor who you feel has your best interest in mind. The ones who explain these things openly, honestly and in sufficient detail should be the lender of choice.
Problem is that industry wide, originators do not complete the TIL correctly or info can be missing which changes the TIL integrity as well.
Something nobody has mentioned is Mortgage Insurance. Take FHA for example, it carries 2 types of Mortgage Insurance which both effect the APR.
The monthly MIP is 1.15% of the loan amount paid monthly. So, you would think it adds 1.15% to the APR – but you only pay MIP for the first say 8-11yrs depending on equity. If the originator puts in the wrong estimated appraisal value, the APR get all messed up because the TIL auto calculates the MIP drop off date.
Check APR’s for major differences, but go with the advisor who tailors your loan rate and fee’s to accomodate your goals with the loan. THIS is how you win!