The most common advice? Shop interest rates. Shop and compare the APR (annual percentage rate). Shop fees. So which is it?
Let’s define both Interest Rate and Apr. – This comes from Wikipedia –
Interest Rate – “is the rate at which interest is paid by a borrower for the use of money that they borrower from a lender.”
APR – “is a finance charge expressed as an annual rate.” In simple terms, it’s the cost of your credit expressed as an annual rate.
The APR rate will usually be higher than your note rate, which is your interest rate. Why is this? Because the APR includes certain fees which are calculated into the actual rate. The problem with this is that so many people tell you to use the APR as your measuring tool when shopping with other lenders. But not every lender calculates APR the same. Each lender by law is required to send you a Truth in Lending disclosure which shows you the APR.
Keep in mind, your note rate is what is used to calculate your monthly mortgage payment, not the APR rate.
So why can comparing one lender’s APR with another be misleading or incorrect? Because some lenders can leave some fees out that aren’t mandatory. The rules are not clearly defined. Sound confusing?
So, what fees are included in the APR?
These fees are generally included :
- Points – both origination and discount
- Underwriting, loan processing, and document prep fees
- commitment fee
- attorney and or title closing fees
- PMI (private mortgage insurance) or MIP for FHA (Mortgage insurance premium)
- Prepaid interest – Interest that is paid from the time that you close to the end of the month. The problem here is that some lenders put 1 day or 5 days down on your good faith estimate. Even if they don’t know your closing date.
Sometimes included :
- Application fee
- Tax related service fee
Generally not included :
- Appraisal fee
- Credit report fee
- Title fee
- Recording fees
Conclusion : What is the overall function of the APR? It’s supposed to measure the ‘true cost’ of the loan. Its supposes to create fairness and a level playing field amongst other lenders. In my opinion, it’s why comparing the APR could be a negative thing.
Another issue about the APR is that it’s based on the length of that mortgage. If you are applying for a 30 year mortgage, it will be based on 365 months. Keeping in mind that the average person moves out of their house in 6.7 years and/or would refinance their mortgage in 4 to 7 years. Overall, it’s extremely rare that someone would keep that same mortgage for the full length.
My opinion? Use the TIL (Truth in Lending) disclosure as a helpful tool to ask questions as to why it might be higher or lower than another companies’ disclosure. How would do this? By breaking down the lenders’ true costs and compare the interest rate. I would advise learning to shop your interest rate and mortgage properly.
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