Thursday, September 20, 2007

What Does an Annual Percentage Rate Mean to Me?

On Monday I linked to an article advising homebuyers to make sure they read the Truth-in-Lending Disclosure which calculates the annual percentage rate on the loan they're about to accept. People also use this calculation when they're shopping for a lender in advance. Chances are if you ask half a dozen Loan Officers what the APR means, six of them will tell you it doesn't really mean anything, it's just a dumb calculation the government makes us do, and that nobody really understands it or knows how to explain it anyway.

But that's only partially true. It does have limited usefulness and there are better ways to determine what kind of deal you're getting on your loan, but it does mean something, and as luck would have it, I even know what that is! So I'll let you in on the secret -- then, if you have to, you can even explain it to your Loan Officer.

A Truth-in-Lending Disclosure contains four boxes across the top:

Box 1) Annual Percentage Rate -- The cost of your credit expressed as an annual rate. Because you may be paying loan discount "points" and other "prepaid" finance charges at closing, the APR disclosed is often higher than the interest rate on your loan. All of the items on your Good Faith Estimate are figured into this calculation EXCEPT the following: Appraisal, Credit Report, Homeowners Insurance, Property Taxes and Title Insurance

Box 2) Finance Charge -- The cost of your credit expressed in dollars. It's the total amount of interest calculated at the interest rate over the life of the loan, plus Prepaid Finance Charges and the total amount of any required mortgage insurance charged over the life of the loan.

Box 3) Amount Financed -- The loan amount applied for, minus the Prepaid Finance Charges. Prepaid Finance Charges include items paid at or before settlement, such as loan origination, commitment or discount fees ("points"), adjusted interest, and initial mortgage insurance premium. The Amount Financed is lower than the amount you applied for because it represents a NET figure. If you applied for $50,000 and the Prepaid Finance Charges total $2,000. the Amount Financed would be $48,000. The idea being that even if you borrow $50,000, if you had to pay $2,000 to borrow it, you ESSENTIALLY only borrowed $48,000.

Box 4) Total of Payments -- The total amount you will have paid if you make the minimum required payments for the entire term of the loan (you'll want to have a tissue handy if you tend to be a weepy sort --- it's a big, ugly number). This includes principle, interest and mortgage insurance premiums, but does not include payments for real estate taxes or property insurance premiums.

It's important to take a good look at your Truth-in-Lending disclosure, but if you're comparing lenders or making sure you understand your loan documents, it's much more straightforward (and you'll get a more accurate result) if you compare rates, fees, monthly payments and loan amounts from the Good Faith Estimate (and the Note, if you're at closing). It's difficult to verify just from a TIL exactly what you're comparing.

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