How APR Can Cost You

A borrower who is shopping for the best mortgage rate can easily be seduced by low rate offers that are accompanied by low Annual Percentage Rates (APR). Federal Law requires that APR be disclosed along side the actual interest rate…this is in order to help borrowers make a more informed decision on their mortgage. The truth is that APR is a very poor way to comparison shop for a mortgage and can cause borrowers to make costly wrong decisions.APR was created in order to provide a way for borrowers to account for costs associated with the mortgage. This sounds good because it may not be very easy to choose between a loan with a lower rate and higher fees or a loan at a higher rate and low fees. The problem is that the APR calculation makes some very bad assumptions. First, APR assumes zero inflation and that the value or buying power of a Dollar today will be exactly equal to the value of a Dollar 10, 20 even 30 years from now. Next, the APR calculation assumes that the mortgage will never be prepaid or paid off. That means no refinancing or selling the home…highly unlikely since the average life of a home mortgage loan is less than four years. Just think, about your own clients. Is it not rare to see the same loan in place for even 5-years…forget 30-years. The APR calculation does not consider the value of the money used for fees. So if you spent thousands of dollars in points or fees to get a lower rate, the APR calculation does not give any value to the money if it were not spent on closing costs. Finally, APR does not take tax consequences into consideration. This can be significant since higher fees on the mortgage may not be deductible while the higher interest rate typically is deductible. Moreover, APR can be manipulated, making it totally worthless.So how does APR work anyway? I like to explain it to my clients by using triangles. I often draw two sets of triangle for my clients to illustrate the difference between Interest Rate and APR. The reason for the triangle is because there are 3 sources of input…”Interest Rate”, “Mortgage Amount” and “Monthly Payment”. If you know any two of the three, you can calculate the third. See the triangle below.

  
     
     
 

Since any two of the three variables allows you to calculate the third, a $911 monthly payment for a $150,000 mortgage calculates to an interest rate of 6.125%. But the APR calculation uses different information. The APR calculation only keeps the “Monthly Payment” information the same. Instead of the “Mortgage Amount”, APR uses “Amount Financed”. This is the “Amount Financed” information on the Truth in Lending statement. Amount Financed takes into consideration the fees that are lender imposed. This includes application fees, points, commitment fees…and interim or per diem interest. So, Amount Financed is the mortgage amount less any lender fees, points and interim interest. The more fees, the lower the Amount Financed. The monthly payment is then calculated as a product of the Amount Financed to give you the “Annual Percentage Rate” or “APR”. So the lower the “Amount Financed”, the higher the “APR” is. Amount Financed can be manipulated by assuming a closing on the last day instead of the first day of the month. That would increase the Amount Financed and decrease the APR.

  
     
     
 

Here is a real example on a $150,000 fixed rate 30-year mortgage with zero points: Lender “A” (triangle above) is offering a great low rate of 5.875% and lender “B” (triangle below) is offering a higher rate of 6.125%.

  
     
     
 

A closer look shows that Lender “A” is charging $3,000 more in fees than Lender “B”. How do you compare? If you look at APR, Lender “A” (5.875% with $3,000 higher fees) has an APR of 6.149%. Lender “B” (6.125% but a $3,000 savings in fees) has an APR of 6.211%. So according the APR, Lender A is a better deal even though the fees are $3,000 higher…this is exactly what these high fee lenders are hoping you look at.

Let’s look at the real story. The payment difference between the two is $24 per month. So is it worth paying $3,000 in fees to Lender A in order to save $24 per month? Hardly. It will take 10.5 years for a borrower to just to get back their investment! A bad choice when you consider that mortgage loans typically are retired within four years. To make the decision to go with Lender “A” even worse, if that’s possible, borrowers rarely take the value of today’s dollars into account. Rather than giving Lender “A” the windfall of your hard earned $3,000, you should give it to yourself. Reduce the loan balance on your mortgage by the fees you are saving. In the example above that would reduce the loan from $150,000 to $147,000. This makes the payment difference just $6 per month instead of $24 per month! The true time to break even is really 500 months (more than 40-years!). So it is impossible to benefit from the higher fee program from Lender “A” because the maximum period on the loan is 30 years or 360 months. One more thing…when you calculate your tax deduction on the payment difference, it makes even more sense to avoid paying higher non deductible fees. The obvious correct choice is to go with Lender “B” even though the APR is lower with Lender “A”.

Bottom line…think twice about those advertised low rates when they are accompanied by higher fees.

THE INSIDE SCOOP ON HOW TO DO IT RIGHT!
First: make sure you are working with an experienced, professional loan officer. The largest
financial transaction of your life is far too important to place into the hands of someone who is
not capable of advising you properly and troubleshooting the issues that may arise along the
way. But how can you tell?
Here are FOUR SIMPLE QUESTIONS YOUR LENDER ABSOLUTELY MUST BE ABLE TO ANSWER
CORRECTLY. IF THEY DO NOT KNOW THE ANSWERS…RUN…DON’T WALK… RUN…TO A
LENDER THAT DOES!
1) What are mortgage interest rates based on? (The only correct answer is Mortgage Backed
Securities or Mortgage Bonds, NOT the 10-year Treasury Note. While the 10-year Treasury Note
sometimes trends in the same direction as Mortgage Bonds, it is not unusual to see them move
in completely opposite directions. DO NOT work with a lender who has their eyes on the wrong
indicators.)
2) What is the next Economic Report or event that could cause interest rate movement? (A
professional lender will have this at their fingertips. For an up-to-date calendar of weekly
economic reports and events that may cause rates to fluctuate, visit www.suewoodard.com and
hit the green MMG Weekly banner – this is a copy of our weekly newsletter, let us know if you
want to be added to my weekly distribution list)
3) When Bernanke and the Fed “change rates”, what does this mean… and what impact does this
have on mortgage interest rates? (The answer may surprise you. When the Fed makes a move,
they can change a rate called the “Fed Funds Rate” or “Discount Rate”. These are both very
short- term rates that impact credit cards, Home Equity credit lines, auto loans and the like. On
the day of the Fed move, Mortgage rates most often will actually move in the opposite direction
as the Fed change. This is due to the dynamics within the financial markets in response to
inflation. For more information and explanation, just give us a call).
4) Do you have access to live, real time, mortgage bond quotes? (If a lender cannot explain how
Mortgage Bonds and interest rates are moving in real time and warn you in advance of a costly
intra-day price change, you are talking with someone who is still reading yesterday’s newspaper,
and probably not a professional with whom to entrust your home mortgage financing. Would you
work with a stockbroker who is only able to grab yesterday’s paper to tell you how a stock traded
yesterday, but had no idea what the movement looks like at the present time and what market
conditions could cause changes in the near future? No way!)
Be smart… Ask questions… Get answers!
More than likely, this is one of the largest and most important financial transactions you will ever
make. You might do this only four or five times in your entire life… but we do this every single
day. It’s your home and your future. It’s our profession and our passion. We’re ready to work for
your best interest.
Once you are satisfied that you are working with a top-quality professional mortgage advisor,
here are the rules and secrets you must know to “shop” effectively.
First, IF IT SEEMS TOO GOOD TO BE TRUE, IT PROBABLY IS. But you didn’t really need us to
tell you that, did you? Mortgage money and interest rates all come from the same places, and if
something sounds really unbelievable, better ask a few more questions and find the hook. Is
there a prepayment penalty? If the rate seems incredible, are there extra fees? What is the
length of the lock-in? If fees are discounted, is it built into a higher interest rate?
Second, YOU GET WHAT YOU PAY FOR. If you are looking for the cheapest deal out there,
understand that you are placing a hugely important process into the hands of the lowest bidder.
Best case, expect very little advice, experience and personal service. Worst case, expect that
you may not close at all. All too often, you don’t know until it’s too late that cheapest isn’t BEST.
But if you want the cheapest quote – head on out to the Internet, and we wish you good luck.
Just remember that if you’ve heard any horror stories from family members, friends or coworkers
about missed closing dates, or big surprise changes at the last minute on interest rate or
costs…these are often due to working with discount or internet lenders who may have a serious
lack of experience. Most importantly, remember that the cheapest rate on the wrong strategy can
cost you thousands more in the long run. This is the largest financial transaction most people
will make in their lifetime. That being said – we are not the cheapest. Of course our rates and
costs are very competitive, but we have also invested in the systems and team we need to ensure
the top quality experience that you deserve.
Third, MAKE CORRECT COMPARISONS. When looking at estimates, don’t simply look at the
bottom line. You absolutely must compare lender fees to lender fees, as these are the only ones
that the lender controls. And make sure lender fees are not “hidden” down amongst the title or
state fees. A lender is responsible for quoting other fees involved with a mortgage loan, but since
they are third party fees – they are often under-quoted up front by a lender to make their bottom
line appear lower, since they know that many consumers are not educated to NOT simply look at
the bottom line! APR? Easily manipulated as well, and worthless as a tool of comparison.
Fourth, UNDERSTAND THAT INTEREST RATES AND CLOSING COSTS GO HAND IN HAND. This
means that you can have any interest rate that you want – but you may pay more in costs if the
rate is lower than the norm. On the other hand, you can pay discounted fees, reduced fees, or
even no fees at all – but understand that this comes at the expense of a higher interest rate.
Either of these balances might be right for you, or perhaps somewhere in between. It all depends
on what your financial goals are. A professional lender will be able to offer the best advice and
options in terms of the balance between interest rate and closing costs that correctly fits your
personal goals.
Fifth, UNDERSTAND THAT INTEREST RATES CAN CHANGE DAILY, EVEN HOURLY. This means
that if you are comparing lender rates and fees – this is a moving target on an hourly basis. For
example, if you have two lenders that you just can’t decide between and want a quote from each
– you must get this quote at the exact same time on the exact same day with the exact same
terms or it will not be an accurate comparison. You also must know the length of the lock you
are looking for, since longer rate locks typically have slightly higher rates.
Again, our advice to you is to be smart. Ask questions. Get answers.
As you can imagine, we wouldn’t be encouraging you to shop around if we weren’t pretty
confident that we feel that we can give you a great value and serve you the very best.
Please call us with any further questions you may have at this time – we are ready to
work for your best interest!
The Sue Woodard TEAM
900 Long Lake Road • Suite 270 • New Brighton, MN 55112 • 651-631-0911 Office • 651-631-1512 FaxTHE INSIDE SCOOP ON HOW TO DO IT RIGHT!
First: make sure you are working with an experienced, professional loan officer. The largest
financial transaction of your life is far too important to place into the hands of someone who is
not capable of advising you properly and troubleshooting the issues that may arise along the
way. But how can you tell?
Here are FOUR SIMPLE QUESTIONS YOUR LENDER ABSOLUTELY MUST BE ABLE TO ANSWER
CORRECTLY. IF THEY DO NOT KNOW THE ANSWERS…RUN…DON’T WALK… RUN…TO A
LENDER THAT DOES!
1) What are mortgage interest rates based on? (The only correct answer is Mortgage Backed
Securities or Mortgage Bonds, NOT the 10-year Treasury Note. While the 10-year Treasury Note
sometimes trends in the same direction as Mortgage Bonds, it is not unusual to see them move
in completely opposite directions. DO NOT work with a lender who has their eyes on the wrong
indicators.)
2) What is the next Economic Report or event that could cause interest rate movement? (A
professional lender will have this at their fingertips. For an up-to-date calendar of weekly
economic reports and events that may cause rates to fluctuate, visit www.suewoodard.com and
hit the green MMG Weekly banner – this is a copy of our weekly newsletter, let us know if you
want to be added to my weekly distribution list)
3) When Bernanke and the Fed “change rates”, what does this mean… and what impact does this
have on mortgage interest rates? (The answer may surprise you. When the Fed makes a move,
they can change a rate called the “Fed Funds Rate” or “Discount Rate”. These are both very
short- term rates that impact credit cards, Home Equity credit lines, auto loans and the like. On
the day of the Fed move, Mortgage rates most often will actually move in the opposite direction
as the Fed change. This is due to the dynamics within the financial markets in response to
inflation. For more information and explanation, just give us a call).
4) Do you have access to live, real time, mortgage bond quotes? (If a lender cannot explain how
Mortgage Bonds and interest rates are moving in real time and warn you in advance of a costly
intra-day price change, you are talking with someone who is still reading yesterday’s newspaper,
and probably not a professional with whom to entrust your home mortgage financing. Would you
work with a stockbroker who is only able to grab yesterday’s paper to tell you how a stock traded
yesterday, but had no idea what the movement looks like at the present time and what market
conditions could cause changes in the near future? No way!)
Be smart… Ask questions… Get answers!
More than likely, this is one of the largest and most important financial transactions you will ever
make. You might do this only four or five times in your entire life… but we do this every single
day. It’s your home and your future. It’s our profession and our passion. We’re ready to work for
your best interest.
Once you are satisfied that you are working with a top-quality professional mortgage advisor,
here are the rules and secrets you must know to “shop” effectively.
First, IF IT SEEMS TOO GOOD TO BE TRUE, IT PROBABLY IS. But you didn’t really need us to
tell you that, did you? Mortgage money and interest rates all come from the same places, and if
something sounds really unbelievable, better ask a few more questions and find the hook. Is
there a prepayment penalty? If the rate seems incredible, are there extra fees? What is the
length of the lock-in? If fees are discounted, is it built into a higher interest rate?
Second, YOU GET WHAT YOU PAY FOR. If you are looking for the cheapest deal out there,
understand that you are placing a hugely important process into the hands of the lowest bidder.
Best case, expect very little advice, experience and personal service. Worst case, expect that
you may not close at all. All too often, you don’t know until it’s too late that cheapest isn’t BEST.
But if you want the cheapest quote – head on out to the Internet, and we wish you good luck.
Just remember that if you’ve heard any horror stories from family members, friends or coworkers
about missed closing dates, or big surprise changes at the last minute on interest rate or
costs…these are often due to working with discount or internet lenders who may have a serious
lack of experience. Most importantly, remember that the cheapest rate on the wrong strategy can
cost you thousands more in the long run. This is the largest financial transaction most people
will make in their lifetime. That being said – we are not the cheapest. Of course our rates and
costs are very competitive, but we have also invested in the systems and team we need to ensure
the top quality experience that you deserve.
Third, MAKE CORRECT COMPARISONS. When looking at estimates, don’t simply look at the
bottom line. You absolutely must compare lender fees to lender fees, as these are the only ones
that the lender controls. And make sure lender fees are not “hidden” down amongst the title or
state fees. A lender is responsible for quoting other fees involved with a mortgage loan, but since
they are third party fees – they are often under-quoted up front by a lender to make their bottom
line appear lower, since they know that many consumers are not educated to NOT simply look at
the bottom line! APR? Easily manipulated as well, and worthless as a tool of comparison.
Fourth, UNDERSTAND THAT INTEREST RATES AND CLOSING COSTS GO HAND IN HAND. This
means that you can have any interest rate that you want – but you may pay more in costs if the
rate is lower than the norm. On the other hand, you can pay discounted fees, reduced fees, or
even no fees at all – but understand that this comes at the expense of a higher interest rate.
Either of these balances might be right for you, or perhaps somewhere in between. It all depends
on what your financial goals are. A professional lender will be able to offer the best advice and
options in terms of the balance between interest rate and closing costs that correctly fits your
personal goals.
Fifth, UNDERSTAND THAT INTEREST RATES CAN CHANGE DAILY, EVEN HOURLY. This means
that if you are comparing lender rates and fees – this is a moving target on an hourly basis. For
example, if you have two lenders that you just can’t decide between and want a quote from each
– you must get this quote at the exact same time on the exact same day with the exact same
terms or it will not be an accurate comparison. You also must know the length of the lock you
are looking for, since longer rate locks typically have slightly higher rates.
Again, our advice to you is to be smart. Ask questions. Get answers.
As you can imagine, we wouldn’t be encouraging you to shop around if we weren’t pretty
confident that we feel that we can give you a great value and serve you the very best.
Please call us with any further questions you may have at this time – we are ready to
work for your best interest!
The Sue Woodard TEAM
900 Long Lake Road • Suite 270 • New Brighton, MN 55112 • 651-631-0911 Office • 651-631-1512 FaxTHE INSIDE SCOOP ON HOW TO DO IT RIGHT!
First: make sure you are working with an experienced, professional loan officer. The largest
financial transaction of your life is far too important to place into the hands of someone who is
not capable of advising you properly and troubleshooting the issues that may arise along the
way. But how can you tell?
Here are FOUR SIMPLE QUESTIONS YOUR LENDER ABSOLUTELY MUST BE ABLE TO ANSWER
CORRECTLY. IF THEY DO NOT KNOW THE ANSWERS…RUN…DON’T WALK… RUN…TO A
LENDER THAT DOES!
1) What are mortgage interest rates based on? (The only correct answer is Mortgage Backed
Securities or Mortgage Bonds, NOT the 10-year Treasury Note. While the 10-year Treasury Note
sometimes trends in the same direction as Mortgage Bonds, it is not unusual to see them move
in completely opposite directions. DO NOT work with a lender who has their eyes on the wrong
indicators.)
2) What is the next Economic Report or event that could cause interest rate movement? (A
professional lender will have this at their fingertips. For an up-to-date calendar of weekly
economic reports and events that may cause rates to fluctuate, visit www.suewoodard.com and
hit the green MMG Weekly banner – this is a copy of our weekly newsletter, let us know if you
want to be added to my weekly distribution list)
3) When Bernanke and the Fed “change rates”, what does this mean… and what impact does this
have on mortgage interest rates? (The answer may surprise you. When the Fed makes a move,
they can change a rate called the “Fed Funds Rate” or “Discount Rate”. These are both very
short- term rates that impact credit cards, Home Equity credit lines, auto loans and the like. On
the day of the Fed move, Mortgage rates most often will actually move in the opposite direction
as the Fed change. This is due to the dynamics within the financial markets in response to
inflation. For more information and explanation, just give us a call).
4) Do you have access to live, real time, mortgage bond quotes? (If a lender cannot explain how
Mortgage Bonds and interest rates are moving in real time and warn you in advance of a costly
intra-day price change, you are talking with someone who is still reading yesterday’s newspaper,
and probably not a professional with whom to entrust your home mortgage financing. Would you
work with a stockbroker who is only able to grab yesterday’s paper to tell you how a stock traded
yesterday, but had no idea what the movement looks like at the present time and what market
conditions could cause changes in the near future? No way!)
Be smart… Ask questions… Get answers!
More than likely, this is one of the largest and most important financial transactions you will ever
make. You might do this only four or five times in your entire life… but we do this every single
day. It’s your home and your future. It’s our profession and our passion. We’re ready to work for
your best interestHERE’S THE INSIDE SCOOP ON HOW TO DO IT RIGHT!
First: make sure you are working with an experienced, professional loan officer. The largest
financial transaction of your life is far too important to place into the hands of someone who is
not capable of advising you properly and troubleshooting the issues that may arise along the
way. But how can you tell?
Here are FOUR SIMPLE QUESTIONS YOUR LENDER ABSOLUTELY MUST BE ABLE TO ANSWER
CORRECTLY. IF THEY DO NOT KNOW THE ANSWERS…RUN…DON’T WALK… RUN…TO A
LENDER THAT DOES!
1) What are mortgage interest rates based on? (The only correct answer is Mortgage Backed
Securities or Mortgage Bonds, NOT the 10-year Treasury Note. While the 10-year Treasury Note
sometimes trends in the same direction as Mortgage Bonds, it is not unusual to see them move
in completely opposite directions. DO NOT work with a lender who has their eyes on the wrong
indicators.)
2) What is the next Economic Report or event that could cause interest rate movement? (A
professional lender will have this at their fingertips. For an up-to-date calendar of weekly
economic reports and events that may cause rates to fluctuate, visit www.suewoodard.com and
hit the green MMG Weekly banner – this is a copy of our weekly newsletter, let us know if you
want to be added to my weekly distribution list)
3) When Bernanke and the Fed “change rates”, what does this mean… and what impact does this
have on mortgage interest rates? (The answer may surprise you. When the Fed makes a move,
they can change a rate called the “Fed Funds Rate” or “Discount Rate”. These are both very
short- term rates that impact credit cards, Home Equity credit lines, auto loans and the like. On
the day of the Fed move, Mortgage rates most often will actually move in the opposite direction
as the Fed change. This is due to the dynamics within the financial markets in response to
inflation. For more information and explanation, just give us a call).
4) Do you have access to live, real time, mortgage bond quotes? (If a lender cannot explain how
Mortgage Bonds and interest rates are moving in real time and warn you in advance of a costly
intra-day price change, you are talking with someone who is still reading yesterday’s newspaper,
and probably not a professional with whom to entrust your home mortgage financing. Would you
work with a stockbroker who is only able to grab yesterday’s paper to tell you how a stock traded
yesterday, but had no idea what the movement looks like at the present time and what market
conditions could cause changes in the near future? No way!)
Be smart… Ask questions… Get answers!
More than likely, this is one of the largest and most important financial transactions you will ever
make. You might do this only four or five times in your entire life… but we do this every single
day. It’s your home and your future. It’s our profession and our passion. We’re ready to work for
your best interest.