Texas Mortgage: What is the APR and why is it higher than the rate?

What in is a TIL (Truth in Lending) Statement and how is an APR (Annual Percentage Rate) Calculated?  Why is the APR higher than the interest rate?

I’ve been a mortgage guy for over 7 years and one of the most common questions I get is “why is the APR different than the interest rate”? 

Sometimes we even get to the closing office and the client mistakenly thinks their rate has been increased when they review the TIL.   The TIL or Truth in Lending document is where the APR is disclosed.

First of all,  the interest rate is the rate in which you are acquiring money.  Normally, this is for a 30 or 15 year term.  For this example, let’s say the interest rate is 4.00% and but the APR is, say, 4.5%. The APR reflects the cost of money (in a percentage form) for the first year.   It’s the percentage rate when you calculate the fees FOR THE FIRST YEAR.

For example, if you get a mortgage you’ll have an appraisal, underwriting fee, and title fee.  These are typical closing costs wherever you go.

 The APR puts these fees into a percentage and gives you a % which is called the APR.

Since there are closing costs associated with any mortgage or refinance, it stands to reason that the APR should be higher than the interest rate.  

 Along those lines, the APR should be a way to determine if  mortgage company A has higher fees than Mortgage Company B.

For example, if Wells Fargo is offering a 4.00%/4.75% APR but Chase Home Loans is offering a 4.00%/4.5% APR than Wells has a better loan or one with LOWER fees, since the APR is lower.

In a perfect world, the APR should be the only thing you consider when deciding on an APR.  Right?

Wrong.

Let’s go back to what the APR is.  Remember, the cost of money for the first year (fees to get the loan) = APR.   Will you have the closing costs/ fees the following year, the year after you refinance or buy?  No.  Will you pay an appraisal, underwriting, title, etc the subsequent years after you buy or refinance ?  NO.   Remember, APR is the cost of money (fees)  for the first year.

http://en.wikipedia.org/wiki/Annual_percentage_rate

The APR was “invented” so that consumers could easily determine the rate and the fees for a particular lender.  This is why the Big Banks give you the Interest Rate and the APR.  Sometimes they’ll make it even more confusing by giving you the buy down points too.

If you call a big bank (Bank of America, Wells, Chase Home Loans) they’ll say, “Our rate is 4.00% with an APR of 4.5% @ 1.25% points”?

Huh?

If you translate this into non-mortgage speak, what they really mean is:   Our 30 year rate is 4.00% and to get this 4.00% you must pay 1.25% points (points is 1% of the cost of the loan, sometimes called buy-down) and the APR (Annual Percentage Rate) is 4.5%.

Line 802/Discount Points and the APR

One aspect to the APR that can be misleading is when you buy the rate down-usually in line 802–on the GFE.  These discount points are NOT calculated into the APR.    Buy down “points’ are also called discount points and this section is NOT put into the APR. 

The fact that a lender can put his/her fees into the discount fee section (line 802) means the lender can camouflage their APR.   For example, if you get a 4.0% interest rate and the APR is also 4.00% how could one’s closing costs still be be $5.00? 

How could the closing cost be 5K when the APR is the exact number as the interest rate? Based on conventional wisdom, the when the interest rate and the APR are the same there should be ZERO closing costs, right? 

So how could a lender have high fees and give you and identical rate/APR?   It’s because the lender/bank can put their fees into line 802…which is NOT calculated into the APR.  The fact that there are some fees that are not calculated into the APR makes the APR, in my humble opinion, a less than reliable way of calculated the fees in a mortgage.

So the easiest way to truly calculate the APR is to ignore it.  By ignore it I mean simply look at the physical dollars it’s going to take to acquire the money for your loan.  Just look at the “bottom line”. 

For example, if Bank of America is offering a 4.00% rate and their bottom line closing costs are $4,000 (appraisal, underwriting, title, processing) But Mylendingplace.com is offering a 4.125% with only $2800 in bottom line, physical dollars, closing costs…then clearly www.mylendingplace.com is the way to go. 

Choosing a mortgage is difficult.  There are lots of pieces to consider.   However, we try to keep the mortgage process simple and predictable.  This is one reason we don’t charge points. 

 My advice is simply this:  

Look at the bottom line payment, look at the bottom line closing costs (regardless if they are APR closing costs or regular closing costs) and decide which bank and which loan is best for you.

Because while the APR is supposed to be a reliable way to calculate fees, the fact that discount points are NOT considered in the APR this fact makes the APR a less than reliable way to calculate the cost of money.

PS.  And since we are giving mortgage advice, Don’t get a loan with PMI and don’t pay points.  

PSS.  And if you’re buying a home-have the seller pay the closing costs.  The less you have to pay, the better.

Www.mylendingplace.com  has been in business for 5 years and we close home loans all over Texas.  If you have a Texas zip code we can help you buy or refinance.   If you are looking to buy a home without PMI and without points call us!  We also do a lot of refinancing and lots of Texas home equity loans, too.