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USING THE ANNUAL PERCENTAGE RATE TO COMPARE LENDERS

When you get your initial rate and fee quotes from your loan officer, you may be confused by the annual percentage rate, or APR. In fact, many loan officers dismiss the APR altogether, calling it misleading and hard to understand. I disagree. The APR is a tool to compare lenders. But it cannot be discussed meaningfully without a thorough explanation of closing costs and their relation to the interest rate attached to the note. That's why we're explaining it in this chapter. But it should be used as an adjunct to the sections in chapter 3 on finding the best lender.

The APR is the cost of money borrowed, expressed as an annual rate. The APR number is an interest rate that takes into account your note rate on your quoted mortgage plus additional lender fees such as discount points, origination fees, and underwriting charges required to get the mortgage.

The APR takes into account these different fees and works out an interest rate. It is designed to provide an immediate comparison between two or more lenders. In the previous example, because Lender B had more loan charges (points), the APR would be higher, even though the note rate was the same.

Lender A quoted 6 percent with $2,000 in points and Lender B quoted 6 percent with $3,000 in points. Because of the different lender charges, Lender B's APR would be higher, indicating the lender charged more in fees.

Let's review the APR for this same example on a $200,000 mortgage and a 30-year fixed-rate loan.

Appraisal

$ 350

$ 350

Credit Report

$ 20

$ 20

Points

$2,000

$3,000

Processing

$ 400

$ 400

Total

$2,770

$3,770

Note Rate

6.00%

6.00%

APR

6.13%

6.18%

Lender B's APR is higher than Lender A's and shows that Lender B is charging more in fees.

Used properly, the APR shows who has the best deal. But you must take certain precautions because that number, too, can be manipulated.

To properly compare APRs, make sure your note rates are exactly the same on the very same loan program. APR comparisons won't work very well if note rates are different. Second, make sure the loan officer doesn't include any prepaid interest charges.

Prepaid (per diem) interest is a factor when calculating APR. As you may recall, prepaid interest will be lower if you close at the end of the month and higher if you close toward the first of the month.

If you know you're closing on the 20th, make sure that all lender quotes include the exact same number of days of prepaid interest in their calculations. For best results, have them calculate the APR with zero days of prepaid interest charges.

Because APR comparisons only work when the loan terms are the same, you can't compare a fixed rate with an adjustable rate or a hybrid. And comparing different loan terms won't work either.

But the APR is a good, quick way to tell who might be loading up on lender fees — as long as you're comparing the exact same loan terms and note rate.

Another easy way to compare good-faith estimates: Simply disregard nonlender charges altogether. This is what I call “comparing the 800 series.”

Because the 800 series are the only charges the loan officer can accurately quote, comparing nonlender charges on the good-faith estimate is a waste of time.

Loan officers have a fairly good grip on closing costs. But a mortgage broker may not know exactly who the lender will ultimately be. Wholesale lenders who work with mortgage brokers have different fees.

 
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