What is the APR (Annual Percentage Rate) of a Mortgage Real Estate Loan?
The annual percentage rate (APR) is an interest rate that is different from the actual note rate. This APR rate allows the borrower to compare loan programs from different lenders. The Federal Truth-in-Lending law requires companies to disclose the APR when they advertise a rate.
The APR does NOT affect the monthly payments. The monthly payments are calculated from the note rate and the length of the loan. BUT it DOES affect the TRUE rate of interest paid on the rate of return that the lender actually RECEIVES.
The APR can be a very confusing number! The APR is designed to measure the "true cost of a loan." It is intended to create a level playing field for lenders and prevent lenders from advertising a low rate and not disclosing some fees.
The APR is the true interest rate you are paying on the money received by the borrower after closing costs have been deducted.
That is to say, you take the loan you are going to be paying interest on, subtract the Prepaid Charges and recalculate the interest rate.
Regulation Z of the Federal Truth-in-Lending law states that all Prepaid Finance Charges must be considered and included in the calculation of the APR of a loan.
But which costs are considered Prepaid Finance Charges? The following lists what should be included as Prepaid Finance Charges in calculating the APR. While this list is not all-inclusive, it does show costs that should be included. These are fees mortgage brokers and lenders would generally include on a Good Faith Estimate for a residential refinance loan. A purchase money loan may also include transfer taxes.
PREPAID FINANCE CHARGES:
- Origination Fee and Points on the loan
- Discount Fee (credit to borrower for chosen rate)
- Processing Fee (by Mortgage Loan Originator or lender)
- Underwriting Fee & Other Fees (by the lender)
- Tax Service (also normally charged by the lender)
- Flood Certification (this fee is also usually charged by the lender)
- Interest Adjustment (Prepaid interest on the new loan)
- Upfront Private Mortgage Insurance Premium (if required)
- Reserves (Monthly) for PMI or MIP (if required)
- Closing/Escrow Fee
- Wire/Messenger Fees
By contrast the following closing costs are not included in calculating the APR. While not all-inclusive, these loan costs are normally found on Good Faith Estimates.
NON-PREPAID FINANCE CHARGES:
- Credit Report Fee
- Title Insurance (For lender title insurance only)
- Hazard (Property) Insurance
- Property Taxes (paid or impounds for reserves)
- Recording Fees
Regulation Z also requires (and expects) that the fees and charges for those services provided as stated above (and on the Good Faith Estimate, GFE) should be reasonable and common for that area in which the loan is being done. (Note, many of these fees are commonly regarded as "garbage fees.")
APR for a fixed rate mortgage will always be higher than the Note Rate on that loan. An exception to this would be a "No Cost" loan. Then the APR could be the same or slightly higher than the Note Rate. Remember there is a relationship between the APR on a mortgage and the total Finance Charges. As the Prepaid Finance Charges increase, the APR gets higher over the stated Note Rate (because more costs are included on the loan).