As a borrower compares interest rates from one lender to another when making a decision about which mortgage company to use, the process can be a bit confusing, to say the least. However, the federal government, in all their wisdom, issued a directive for all consumer loans to disclose the Annual Percentage Rate, or APR, to help the borrower compare loan offerings.
The APR is defined as the cost of money borrowed expressed as an annual rate and takes into consideration not only the interest associated with the loan but additional fees needed to close the loan as well. For example, a 30 year mortgage loan at 4.00% on a $200,000 note results in a $954 monthly payment. If the lender also charged a $2,000 origination fee, the APR figure is 4.08. If the lender charged $4,000 in origination fees the APR is 4.17. The higher the lender charges the greater the disparity between the interest rate on the loan and the APR number.
But what are those fees used to help calculate the APR? They’re called finance charges. And all lenders have them.
Finance charges are fees charged directly by the lender or are charges for services required by the lender in order to issue a mortgage loan. A lender can have a $500 processing fee, a $400 underwriting fee and a $2,000 origination charge. Those fees, charged by the lender for lender-performed services are included in the finance charges.
A lender will require several reports before issuing a mortgage yet not perform those services themselves. For example, a credit report and an appraisal will be a required report but performed by third parties. Since the lender will require certain third party reports those third parties will provide the requested information but the borrower will ultimately be responsible for paying them.
The greater the amount of finance charges, the higher the APR number will be compared to the interest rate. Even if two lenders offer the same mortgage rate, they can have two different APR numbers. The lender with the lowest APR in this example will have lower closing costs compared to the other lender. This is how you compare loans from different lenders. Notice the APR and understand how it’s calculated.
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