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Annual Percentage Rate

Earl L. Huse, JD
October 05, 2008
Commonly abbreviated APR. The actual cost of borrowing money, expressed in form of annual rate to make it easy for one to compare cost of borrowing money among several lenders or sellers on credit. . For example: 6% add-on interest would be much more than 6% simple interest, even though both would say 6%. The A.P.R. is disclosed as a requirement of federal truth in lending statutes.

The annual percentage rate (APR) is an interest rate that is different from the note rate. It is commonly used to compare loan programs from different lenders. The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. Typically the APR is found next to the rate.

The APR does NOT affect your monthly payments. Your monthly payments are a function of the interest rate and the length of the loan.

The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the "true cost of a loan." It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.

Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. The best way to compare loans in the author's opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.

The following fees ARE generally included in the APR:

Points - both discount points and origination points

Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!

Loan-processing fee

Underwriting fee

Document-preparation fee

Private mortgage-insurance

The following fees are SOMETIMES included in the APR:

Loan-application fee

Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)

The following fees are normally NOT included in the APR:

Title or abstract fee

Escrow fee

Attorney fee

Notary fee

Document preparation (charged by the closing agent)

Home-inspection fees

Recording fee

Transfer taxes

Credit report

Appraisal fee

An APR does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock may have a lower APR than a lender who offers you a 60-day rate lock!

Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs

Many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!



In comparing any type of loan, whether it be a fixed rate loan to a fixed rate loan, adjustable rate loan to adjustable rate loan or fixed rate loan to adjustable rate loan, there is one way that can be used to compare apples to apples and even apples to oranges.

APRs are designed to do just that. APRs are a way to calculate the annual cost of loans, taking into consideration loan origination fees (points) and the other costs associated with securing a loan. The additional costs include appraisal and credit report fees as well as processing and document fees.

One confusing aspect of APRs is that the APR on 15-year loans will carry a higher relative rate due to the fact that the points are amortized over the 15-year term rather than the 30-year term. (See chart below) When a Regulation Z (Reg Z, the lender's disclosure of cost for the loan) is prepared for a buyer/borrower the prepaid interest is also included in the APR calculation. For our illustrations we will use only the points, appraisal, credit report, processing and document fees.

As a means of protecting consumers from lenders who did not disclose the fees associated with a particularly low start rate on an adjustable rate loan or below market rate on a fixed rate loan, APRs give consumers a way to check the true cost of a loan.

Conclusion:

Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan. Origination, Underwriting, Discount Points, Tax Service, Private Mortgage Insurance, Inspection Fees, FHA Mortgage Insurance, Pre-paid Interest, VA Funding Fee, and Broker Fees.

In comparing any type of loan, whether it be a fixed rate loan to a fixed rate loan, adjustable rate loan to adjustable rate loan or fixed rate loan to adjustable rate loan, there is one way that can be used to compare apples to apples and even apples to oranges.

APRs are designed to do just that. APRs are a way to calculate the annual cost of loans, taking into consideration loan origination fees (points) and the other costs associated with securing a loan. The additional costs include appraisal and credit report fees as well as processing and document fees.

The approximate rate can be found by the following formula:

R = 2n1

P (n+1)

Where:

N = Number of payments per year

I = Finance charge in dollars

P = Principal

N = Number of scheduled installment payments

Assume you make a loan for $5,000.00 for 36 months. If the payments are made monthly and are $162.50 each, the annual percentage rate would be:

R = 2X12 (162.5 X 36 – 5,000)

(5,000 X (36 + 1)

Annual percentage rate would be 11%
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Earl L. Huse, JD

Earl L. Huse is a recognized author on real estate finance and has several books to his credit including Real Estate Law and You, Making of a Professional Loan Officer, and his latest book, Pretty Place USA, For Sale By Owner. He has written and taught Department of Real Estate accredited courses on creative finance, equity share, math of finance and more. Earl has over 1000 real estate seminars to his credit, holds a B.S., J.D., and was founder of the California Orange County Real Estate Marketing Club.

Giving up ´serious´ golf, Earl Huse began his real estate career in the mid 1970's after completing various creative financing seminars and accounting courses in Northern California. While investigating creative financing investment options to meet his personal goals during the late 1960's and early 1970's, he recognized a need for educational presentations dealing with optional methods of real estate financing. Huse moved to Southern California in the early 1970's, and began attending FHA, VA, FHMA, and FHLMC processing and underwriting seminars offered by various agencies. His goal was to have a complete understanding of the real estate loan application and process, from loan generation to loan funding. This knowledge was later used to introduce the general public to the complexity/simplicity of the loan process.

Huse joined a major real estate firm in the mid 1970's, while attending law school. His main function with the real estate firm was to develop continuing education courses that would be approved and accredited in California for licensed real estate agents. He graduated up 1979 with a Juris Doctor in law.

Earl was ultimately successful in obtaining over 120 hours in Department of Real Estate continuing education seminar credits consisting of 5 courses including, Equity Share (the only Equity Share contract approved), Real Estate Law, and Mathematics of Finance.

Because of real estate acquisition opportunities due to increasing interest rates, Huse began a quest to acquire SFR's at drastically reduced prices, with favorable financing options that would benefit both the seller and himself. With the properties in hand, he devised creative financing concepts that were unique in the real estate industry. So unique, as a matter of fact, they were once called the "Earl the Pearl, the Gem of the Sea" financing concepts.

Because of his expertise, Earl was a regular guest speaker on a local radio station that offered creative financing solutions to people calling in with questions. This soon led to a local TV show following the same format.

As a result of the high demand for his services, he developed financial seminars designed to educate the consumer.

Increasing interest rates and foreclosures through out the U.S. in the early 1980's led to the development of creative financing seminars that would do several things for the consumer, including:

1. Teach true ´no money down´ purchase concepts.
2. Teach prospective investors how to properly qualify for loans.
3. Teach people how to understand various real estate loans, and what they are, and,
4. Understanding contracts, how to use them and why (with legal advise), and other concerns.

By popular demand Huse began a seminar trail throughout California, Oregon, Washington, Texas, and Okalahoma. He now has over 1,000 seminars to his credit.

Lending money, buying homes, and seminars soon became a way of life as well as his business, so Earl acquired his own mortgage company. The success of the company afforded him the opportunity to create a real estate marketing club, in Southern California, which offered a consortium of programs to members. Foreclosed properties were the main focus (how to buy, sell, exchange, finance, etc.) along with continuing education on creative financing options, marketing and of course, financing options with the mortgage company. The club, open to the general public, allowed agents and consumers to market their own properties and, with the assistance of Huse, structure creative financing options based on the clients individual needs.

In the late 1980's, Huse liquidated his interest in the mortgage company and marketing club, and retired from the seminar trail to begin other ventures in the mortgage-banking world.

Huse retired in 2000 to write and publish a series of books which include Learn the Secrets of Real Estate Loans; America, I Want Some Real Estate and How to Buy it; Now and Forever, Zero Mortgage Payments, and Pretty Place, U.S.A.- For Sale By Owner, which are available through his website at
www.howtohavezeromortgagepayments.net.