Your interest rate is the cost you pay each year to borrow the money (your loan amount) expressed as a percentage rate. Your rate is used in a mathematical formula with your loan amount and loan term to determine your monthly payment. For example, a $200,000 loan at an interest rate of 4.75% pays the principal balance down to $0 over 30 years (360 payments) with an equal monthly principal and interest payment of $1043.29. In your 1st monthly payment, you owe (4.75% x $200,000)/12 = $791.67 in interest. So the remaining ($1043.29 – $791.67) = $251.62 goes to reduce principal. For the 2nd monthly payment, your loan amount is $199,748.38 and the interest you owe with that 2nd payment is (4.75% x $199,748.38)/12 = $790.67. So in this example, you pay $1.00 less in interest in the 2nd payment. In effect you are whittling away at principal with each monthly payment – and over 360 payments, you will whittle the loan balance down to $0.
Another way to think of the interest rate is as “rent” on the money. Your monthly principal and interest payment is first applied to the interest that accrued in the previous month, and the remaining portion of the payment reduces your principal. Over time, as you pay down principal, less and less of your monthly payment goes towards interest and more and more to principal until the loan is finally paid to $0.
What your interest rate does NOT do is reflect the fees and charges you paid in order to get the loan. This is where APR comes in.
APR or “Annual Percentage Rate” was created to show you the total cost of the loan – including the interest rate AND the loan fees such as any points, lender fees, and other charges that you pay to get the loan and that you would not have paid if you paid cash to buy the home. These fees are considered “prepaid finance charges” because you prepay them at closing to get the loan. For that reason, your APR will be higher than your interest rate.
Regulators require that all lenders disclose an APR whenever they quote an interest rate. The idea is that APR will be helpful when comparing different offers. But comparing offers from a bank, like Wells Fargo or Bank of America, and a correspondent lender like Corporate Investors Mortgage Group is tricky.
For all lenders (banks and correspondent lenders and brokers) if you pay points to buy down your rate, those points are factored into your APR and increase it.
Because banks are regulated differently than correspondent lenders and brokers, Banks are allowed to apply a lender credit / closing cost credit to your APR – and this REDUCES the APR that they disclose.
But if a correspondent lender or a broker gives you the exact same lender credit and it covers any or all of your closing costs, the credit is NOT factored into your APR. For this reason, offers from banks can be misleading.
For example, you could have an offer directly from Wells Fargo that shows a rate of 4.75%, APR fees of $2325 and a lender credit of $2325 – with an APR of 4.764% – and I could give you exactly the same offer but the APR for my offer would be higher.
In the examples below – just looking at Rate and APR doesn’t tell the whole story. Remember that offers C and D can’t reflect the lender credit in the APR.
In this chart showing 4 offers, offer A looks best if you just look at the APR. And offer B looks just as good as offers C and D. But offer C is $1000 better than offer B and equal to offer A, and offer D is the best of these 4 offers.
|Offer A||Offer B||Offer C||Offer D|
|Bank of America|
|a “broker” or “correspondent lender”||Frank Rexford / Corporate Investors Mortgage Group|
For an accurate comparison – you must look at rate, APR fees, Lender Credit and APR. Other fees, such as third party fees, will be the same for whichever lender you choose, so they are not useful in making comparisons. Attorney fees, title insurance fees, homeowner’s insurance premiums, and insurance and tax escrows are not controlled by the lender and they do not impact APR.
Call me at 919-929-6116 if you would like me to explain why D is the best choice.
*APR fees illustrated include Commitment Fee, Credit Report Fee, Flood Certification, Appraisal Fee, Attorney Fee and Per Diem Interest.
NOTE – APR calculations make unrealistic assumptions when calculating APR for ARM’s. The calculations do not take into account how high your rate could actually adjust, and so APR is not helpful.