Do Borrowers Really Understand a Mortgage APR?
As part of obtaining a mortgage, a borrower will be presented with many documents, one of which is the Truth-in-Lending, also known as a TIL. The TIL will list the mortgage rate being quoted, as well as, the annual percentage rate, commonly referred to as the APR. It is also a Federal law that lenders show both the mortgage rate and APR when advertising which prevents lenders from hiding fees. While this percentage is an important piece of information, do borrowers really understand a mortgage APR?
What is APR?
The APR is the annual cost of credit which is calculated as a percentage. It is intended to be a tool by which borrowers can compare different mortgage offers before making a final decision. The APR is almost always higher than the actual mortgage rate of the loan because it includes the interest rates, origination fees, any points, broker fees, mortgage insurance premiums, prepaid interest and any other lender fees that a borrower is obligated to pay as part of the mortgage. However, the APR does not include fees from third parties, such as costs for appraisal, title and inspection, if needed.
There are some tricky aspects to the APR. It is calculated based on the entire term of the loan, such as 30, 15 or 20 years, and with the assumption that the mortgage will never be refinanced. For this reason, borrowers should never compare quotes and APRs for different term loans.
The resulting APR for an ARM (adjustable rate mortgage) is calculated based on the assumption that the mortgage is adjusting at the present time and at the current interest rates since future rates at the time of adjustment are not known. It is not really possible to predict how an ARM will adjust over the entire term of the loan or whether rates will increase or decrease. Due to this, comparing the APR from lender to lender is not dependable since each lender may be use a different ARM adjustment for purposes of the ARM APR.
Another drawback to the APR is that it does not consider that the mortgage will be refinanced, that the home will be sold or that extra payments may be made to the principal balance. While this percentage is designed to give a borrower the true cost of the loan, the actual length of time that a borrower holds the mortgage will really determine the final costs and will tend to be more accurate.
Comparing Loan APR
If a borrower chooses to use the APR to compare mortgage offers, then the lender must give the borrower the details of what fees are included in the APR in order to make a true comparison. Since the costs of a loan will differ from lender to lender, the APR will ultimately be different. When there are one-time charges that a borrower pays upfront, the cost of the loan increases, however, the APR calculates these charges over the entire life of the loan which can result in a lower APR.
Because the APR can be quite confusing, it should not be the deciding factor when obtaining a mortgage. It is better for the borrower to look at the entire mortgage including its costs and terms. Examining the Good Faith Estimate line by line will produce a better comparison of the costs included in the loan. Bear in mind, that each time the mortgage is negotiated or altered, the GFE will also be updated. In addition, the exact costs of some fees are not known at the time of application and may also change the APR prior to closing.
Despite all of the safeguards available for borrowers to make a good mortgage decision, the best mortgage will be the one that the borrower is happy with, satisfied with the mortgage rate and costs, and can live with for a long period of time.
Author Bio: Rosemary Rugnetta has been writing since 2010 for FreeRateUpdate.com, a company that matches consumers with banks and lenders offering low mortgage rates. Previous to her writing career, Rosemary spent 13 years working hands-on in the mortgage industry as a mortgage loan analyst, mortgage processor, mortgage underwriter and property manager.
Image courtesy of FreeDigitalPhotos.net