What Is APR and Why You Shouldn’t Shop For Your Mortgage Using It?

What Is APR and Why You Shouldn’t Shop For Your Mortgage Using It?

Truth-In-Lending snapshot

Do not shop APR when comparing mortgage quotes–APR is the most easily manipulated number in the mortgage business.

What is APR…

More commonly called APR, Annual Percentage Rate is a government-mandated mortgage comparison tool. It measures the total cost of borrowing over the life of a loan into dollars-and-cents.

APR is equal to (your loan size) + (your loan costs) + (your interest charges over time).

A loan’s APR is printed in the top-left corner of the Federal Truth-In-Lending Disclosure, as shown above. When quoting an interest rate, loan officers are required by law to disclose a loan’s APR, too.

APR is meant to simplify the process of choosing between two or more loans. The theory is that the loan with the lowest APR is the “best deal” for the applicant because the loan’s long-term costs are lowest. However, the loan with the lowest APR isn’t always best.

APR makes assumptions in its formula that can render it moot.

First, APR assumes you’ll pay your mortgage off at term, at never sooner. It assumes you won’t refinance or sell. In other words, if your loan is a 30-year fixed rate mortgage, the APR is based on a full 30-year term. If you sell or refinance prior to Year 30, the math used to make your APR becomes instantly flawed and “wrong”.

Example: Let’s compare two identical loans in Pleasanton — one with discount points and a lower interest rate; and one without discount points and a higher mortgage rate. The loan with discount points will have a lower APR in most cases. However, if the homeowner sells or refinances within the first few years, the loan with the higher APR would have been the better option, in hindsight.

APR is misleading in 2011

Second, APR can be “doctored” early in the loan process.

Because the APR formula accounts for third-party costs in a mortgage transaction, and third-party costs aren’t always known at the start of a loan, a bank can inadvertently understate them. This would make the APR appear lower than what it really is, and may mislead a consumer.

And, lastly, APR is particurly unhelpful for adjustable-rate loans. Because the APR calculation makes assumptions about how a loan will adjust during its 30-year term, if two lenders use a different set of assumptions, their APRs will differ — even if the loans are identical in every other way. The lender whose adjustments are most aggressively-low will present the lowest APR.

Summarized, APR is not the metric for comparing mortgages — it’s a metric.

Have a Plan for your Mortgage

Look at interest rate and lender costs when choosing a loan. Even more so SERVICE—I love to work with readers that find my information on the Mortgage and Housing Market helpful in your decision making process. As a Mortgage Planner at Vintage Mortgage Group in Pleasanton I am in a unique position to help you capitalize at any point in the market. Contact me below today to help you with your purchase or refinance.

 

 

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