Everyone has received various credit card offers in the mail that state 0% APR for the first 6 months. Consumers are conditioned to glance past the disclosure part of the offer in fine print explaining how the APR is calculated and simply recognize that it is a good deal…..at least for the first 6 months. You might already know "APR" is an abbreviation for annual percentage rate and it indicates how much is being charged to borrow money. However, you might not be 100% sure how the credit card company is calculating each month.
The interest rate that you are quoted when you apply for the mortgage is the cost you will pay to borrow the money for the home loan. The APR represents the entire cost of the mortgage, including closing costs, and any other charges to get the loan. Therefore, the APR is usually higher than the interest rate. It might be less than one percent higher, but by law, the lenders must have full disclosure to the borrower under the Federal Truth in Lending Act. It is actually wise to look at the APR, not just the interest rate, when applying for a mortgage.
Why do our law makers want Lenders to disclose this particular number? APR is the basis for comparing certain costs of loans. Savvy borrowers should not only compare the interest rates quoted from the Lenders, but focus on the APRs to get a fair comparison of total cost.
The example below will demonstrate just how important the APR is:
Borrower is comparing rates between two Lenders. The current loan balance is $200,000 and the home is worth $250,000. Let’s see how the offers compare: One Lender is offering a rate of 3.625% and the other is 3.75%. He is about to lock with the first Lender when he sees the APR and is wondering why it is higher than the agreed upon interest rate.
Lender 1: 30 year fixed rate mortgage, 3.625% with 1.5 points and $3800 Closing Costs. APR is 3.9. To cover the Closing Costs the new loan amount is $206,500. Based on 3.625% the Principal and Interest payment will be $941.75.
Lender 2: 30 year fixed rate mortgage 3.75% with 0 points and $2400 Closing Costs. APR is 3.84 and the new loan amount is $202,400. Based on 3.75%, even though the rate is HIGHER than the first Lender the Principal and Interest payment will be $923.05. Option two will save the Borrower $6,732 over the term of the mortgage.
By requiring Lenders to disclosure the APR on a loan, Borrowers will get the full picture of costs when comparing the actual APRs. Reviewing the Good Faith Estimate, a borrower can compare and determine how other loan costs such as points can increase the APR. Even though the first loan at the lower interest rate seems like a better option at first glance, it will cost MORE over the life of the loan. If this particular borrower wants to save money, he should go with the second option. Even though the interest rate is technically higher, it is costing him less money for the same loan amount.
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