Interest Rates -v- APR
In comparing any type of loan, whether it be a fixed rate
loan to a fixed rate loan, adjustable rate loan to adjustable rate loan or fixed rate loan
to adjustable rate loan, there is one way that can be used to compare apples to apples and
even apples to oranges.
APRs are designed to do just that. APRs are a way to
calculate the annual cost of loans, taking into consideration loan origination fees
(points) and the other costs associated with securing a loan. The additional costs include
appraisal and credit report fees as well as processing and document fees.
One confusing aspect of APRs is that the APR on 15 year
loans will carry a higher relative rate due to the fact that the points are amortized over
the 15 year term rather than the 30 year term. When a Regulation Z (Reg Z, the mortgage
companies disclosure of cost for the loan) is prepared for a buyer/borrower the prepaid
interest is also included in the APR calculation. For our illustrations we will use only
the points, appraisal, credit report, processing and document fees.
As a means of protecting consumers from companies who did
not disclose the fees associated with a particularly low start rate on an adjustable rate
loan or below market rate on a fixed rate loan, APRs give consumers a way to check the
true cost of a loan.
One common situation that occurs when a borrower receives
a Reg Z, and a copy of their note, is the column that indicates the amount financed is
less than the loan amount the borrower is actually financing. It is here that many
borrowers leap before they look and call to find out why they are only receiving a
$146,925 loan when they applied for a $150,000 loan. It is here that APRs enter the
picture.
Let's look at how APRs are calculated. For our
illustration we will assume a 8.50% fixed rate interest. For a 30 year loan the monthly
payments for a $150,000 loan are $1,153.37.
In order to calculate the APR for this loan we subtract
$2,250.00 (1.50 points), $275.00 appraisal fee, $50.00 credit report fee, $500.00
processing, document and other fees. ($150,000 - $3,0750 = $146,925). The $146,925 is then
used as the present value/loan amount to determine the true cost of this loan. By solving
for the new interest rate for a $146,925 loan with the same payment of $1,153.37, the APR
is calculated as 8.73%.
How does this compare to a 30 year fixed rate loan with a
8.00% interest rate and 3.50 points? The monthly payments for this loan is $1,100.65.
In order to calculate the APR for this loan we subtract
$5,255.00 (3.50 points), $275.00 appraisal fee, $50.00 credit report fee, $500.00
processing, document and other fees. ($150,000 - $6,075 = $143,925). The $143,925 is then
used as the present value/loan amount to determine the true cost of this loan. By solving
for the new interest rate for a $143,925 loan with the payment of $1,100.65 the APR is
calculated as 8.44%. |
