What is Mortgage APR? APR Explained What is mortgage APR?
 
What IS Mortgage APR

APR Demystified and APR Predators

First, lets demystify Annual Percentage Rate (APR).

APR was designed to allow consumers to use one standardized number to compare the real cost of each lender's interest rate and it works like this.

If I lend you, $10,000 and, I charge a $500 Bump-ta-Bump Fee, you will actually receive $9,500, however you must still repay me $10,000. APR is my real yield and your real cost on this loan.

We agreed that you will repay the loan at 8% interest on $10,000, HOWEVER you only received $9,500 therefore I will earn more than the 8.0% interest rate I charge on $10,000. In this case, my yield (APR) is 9.799% on the $9,500 you received.

APR is the lender's yield on dollars actually lent ($10,000 minus $500 = $9,500); in this case, the lender's yield (APR) on $9,500 is 9.799% (APR is computed as if the above example is a 30 year loan)

The $9,500 also represents the Amount Financed in the Truth In Lending (TIL) disclosure.

For those of you who use spreadsheets the Rate Function will find APR. Use the Amount Financed for Loan Amount and use the monthly payment on the actual loan amount.

Fees that must be subtracted from a mortgage loan to properly calculate Amount Financed for APR

  • Origination and Discount Points
  • Processing and Lender Fees
  • Pre-Paid Interest (Use 15 days when closing date is unknown)
  • Monthly Mortgage Insurance must be added to the payment of all FHA loans and Conventional loans greater than 80% loan to value.
  • The inclusion of Mi or MIP accounts for the large spread between Rate and APR on loans with mortgage insurance.
  • Note: Fees Not used in APR calculation; third party fees such as appraisal and credit.

    How Do APR Predators Work?

    Many sophisticated borrowers shop interest rates by searching for lowest APR which, if property stated, is the real cost of borrowing. Unfortunately, APR is not always stated properly.

    How is advertised APR is misstated?

    Rate - Points - Fees are all interdependent

    The best way I can explain this is show various Rate - Point - Fee combinations where the lender is making the same gross profit on each combination.

    In the examples below, we will use a $200,000 loan amount and Lender gross profit of $1,000, on a day when the Lender's cost for a 5.000% rate is par (0 point).

    Best Rate: $1,000 Lender profit in various combinations of points and fees

    Rate

    Fees

    Points

    APR

    Profit

    5.000%

    $1,000

    0

    5.044%

    $1,000

    5.000%

    $500

    0.250

    5.044%

    $1,000

    5.000%

    $0

    0.500

    5.044%

    $1,000

    Lowest Fees: You pay $0 points and fees and Lender's investor pays the lender $1,000 for the higher rate.

    Rate

    Fees

    Points

    APR

    Profit

    5.125%

    $0

    0

    5.125%

    $1,000

    The point here is that lenders design their loans to provide talking points for their sales staff (loan officers). They all require a certain profit margin and it is not important the way the loan is structured as long as the closed loan delivers their margin.

    This illustration also points out the value of correctly stated APR as a way of evaluating the true cost of a mortgage loan. For sake of these illustrations, prepaid interest was not used. If 15 days PP was calculated it would have increased each APR by 0.019%.

    Your FHA GuruBill Ladewig, Your FHA Guru

    800.664.7283 (SAVE)

    Bill@YourFhaGuru.com

    William J. Ladewig
    California Home Loans Since 1970
     











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