Financial Reform laws enacted in 2010 and 2011 were intended to help consumers by bringing transparency to the mortgage transaction. The new APR calculation is misleading, however – especially when comparing bank loans with loans provided by brokers. APR is found on the Truth-In-Lending disclosure. APR is meant to help consumers compare loan offerings; it is not the same as the interest rate (note rate).

The interest rate (note rate) is simple: You borrow a specific amount of money at the note rate, and you make payments based on your loan term. Example: On a $200,000 loan with a 3.5% note rate and 30-year term, the principal and interest payment is $907.07. APR is better described as a “what if” calculation. If the same loan just referenced above had PMI (private mortgage insurance) attached to the loan, that PMI would be factored into the APR. If the PMI were $150/month, the note rate would still be 3.5%, but the APR would be now be 4.06%. The APR factors in the PMI as if it were part of your principal and interest payment.

The real confusion with APR results from the bank & broker profit, and how that profit is disclosed to the borrower. Banks do not have to disclose profit. When the bank sells the mortgage to Fannie Mae or Freddie Mac (within days of closing), they receive a profit margin. For the sake of comparison, let’s say that profit margin is 2%. On a $200,000 transaction, that’s a $4,000 profit that is not disclosed in any way. A broker, however, may provide an identical loan, but is required to disclose that profit as a factor in the APR calculation. The consumer did not pay more. In fact, brokers often discount their profit to be more competitive than the bank. The broker’s loan may be a better rate, lower closing costs, and lower payment, but the APR disclosed will always be higher than the banks because of the legal requirement. The APR in this case is determined by subtracting the profit from the loan amount, but keeping the same payment, then recalculating the rate. The loan amount hasn’t changed. It is still $200,000, but the disclosure now uses $196,000 in the calculation for the broker, even though the loans are identical. A $196,000 loan with the same payment as the $200,000 loan reflects as a higher APR when disclosed this way. The reason why? The $4,000 profit is listed as a charge to the borrower, but then the borrower receives a credit from the lender in the amount of $4,000 to offset. The charge is included in the APR calculation. The credit is ignored.

The answer? Ignore APR. It is completely useless if you are comparing loans between brokers and banks. Brokers don’t always provide better terms; it’s possible that your bank is offering better terms. The problem is that APR cannot be used as a reliable tool to differentiate anymore. You will want to focus on payment, loan amount, note rate, and total closing costs (after the lender credit) to determine the best program.

Adrian Tavolacci, Senior Loan Officer
Team Mortgage 616-298-8210
http://www.GrandRapidsMichiganMortgage.com/

Adrian Tavolacci has been a mortgage loan officer for more than 12 years. He will make sure you get to closing on time, at incredible terms, no surprises.