Comparing Apples to Apples. There is only one meaningful way to compare one mortgage’s total cost against another, and that is the Annual Percentage Rate (APR). The APR is a great idea that was invented by the Federal Government (!!). It’s been around for decades, and a required quotation in the fine print on every mortgage loan, every car loan, and every furniture loan.
Unfortunately, in our world of sound bites and spin, almost nobody really takes the time to understand APRs. If you do take the time, you have an advantage over the rest of the herd.
What the APR does is take into consideration not only the lender’s rate, but also his origination fees, points, and any other “junk fees” that might be added to the loan. (A “point” is 1% of the loan amount, usually a fee charged the borrower, much like closing costs). By comparing APRs you have an apples to apples comparison of the lender’s total costs, compared to the next lender.
It’s not that complicated. All the APR really does is subtract lender origination fees, points, etc from your loan, and recalculate your rate based on your actual payment and that smaller loan amount.
Lender Smith. For example, Lender Smith is hawking a $100,000 loan at 10% for 30 years, which therefore has a payment of $877.57. Simple enough. But hark! You didn’t really get the full use of $100,000, because out of that amount you paid $1500 loan origination fees, plus $500 points, plus $300 junk fees ($2300 total). So you really only got the use of $97,700. But you still have to pay the same $877.57 monthly payment.
So what’s the rate based on that $877.57 payment and a $97,700 loan, for 30 years? The answer (through a magical calculation that you don’t need to understand) is 10.28%. That’s the APR. Note that it’s higher than the lender’s stated rate of 10%.
Lender Jones. Now let’s say Lender Jones down the street is also quoting a 10% rate, and his loan origination fee is only $1000, but he charges points of $2150. (Total costs $3,150). So with this loan you only get the use of $96,850. The APR is 10.38%.
So two lenders are quoting the same rate of 10%, and if you’re rate shopping, they both look the same. But one has an APR of 10.28% and the other 10.38%. Now you have a true basis for comparison.
Of course, when comparing two 10% rates, it’s a simple matter to compare costs without using an APR. But the APR is much more helpful when one lender is quoting, say a 9.375% rate with $1000 points, and the other is quoting, say 9.75% and $500 points.
APRs will almost always be higher than Rates. Remember that it’s normal for APRs to be higher than the rate on the same loan. And don’t worry if you don’t personally know how to calculate APRs. The lenders have to calculate them. All you have to do is compare them. And just remember that the lenders aren’t required to put the APRs in their quotes just to take up white space on the page. APRs are there for a reason.
- Thanks to CrossroadsUSA.com for this info
