APR (Annual Percentage Rate) Is A Poor Judge Of Character

September 14th, 2009

Annual Percentage Rate, or APR, is a legal requirement that mortgage lenders must disclose on one of their disclosures called a “Truth In Lending” statement. It is not a useful way for the consumer to measure the cost of a mortgage.

It is supposed to be a way for lenders to express their closing costs in terms of a percentage. The thinking is that consumers can simply ask lenders for the APR, and can quickly shop mortgage loan offers by analyzing this one number. But things are not that simple.

APR makes no intuitive sense to most consumers, it does not cover all the costs, and does not take into account differences in a consumers’ time horizons, tax rates and opportunity costs. A more accurate way to measure the cost of a loan is to simply take a more involved look at the interest rate and the closing costs from the lender only. To compare loan offerings between lenders the consumer need not look at title costs, per diem interest, tax escrows or state/county recording and transfer taxes. None of these aforementioned costs is dictated by the lender or is part of the loan itself.

Let’s take an example on a mortgage loan for a property in Washington, DC.

Loan option #1:

4.875%, 30 Year Fixed Rate
$500,000 purchase price
$400,000 loan amount
0 discount points
1 point origination fee = $4,000
(each 1 point is 1% of the loan amount)
$350 appraisal
$20 credit report
$350 document preparation fee
$500 underwriting fee
$78 tax service fee
$20 flood certification fee
$5,318 total cost for a 4.875% interest rate

Loan option #2:

5.125%, 30 Year Fixed Rate
$500,000 purchase price
$400,000 loan amount
0 discount points
0 origination fee
$450 appraisal
$10 credit report
$299 document preparation fee
$350 underwriting fee
$98 tax service fee
$30 flood certification fee
$1,237 total cost for a 5.125% interest rate

Most people are so happy to focus on the lower rate of 4.875%, they ignore the hard analysis of the 5.125% loan offer. The costs for the lower rate are $5,318, but the costs for the higher rate are only $1,237. Would you pay an extra $4,081 to get an interest rate that is 0.25% lower? 0.25% of a lower rate saves approximately $64/month on a $400,000 mortgage.

The question should simply be one of recapture period. What am I spending, and what am I saving? So, should you spend $4,081 to save $64/month? This is a 63.7 month recapture period. For most of us, who seem to refinance or move before 5 years comes and goes, I’d think the higher rate is the better deal. The answer for each of us as individuals lies in doing our own analysis.

And most of all, when comparing loan offers, simply look at rates and lender fees, and for the time being, ignore title fees, tax escrows, and all the rest. Those are not controlled by the lender, and have no bearing on the type of financing you get.

Apply for a loan, and if you get multiple loan offers I can help you walk through the details to figure out which one will work best for you.

Brian Martucci is a loan officer for Capital Bank Home Loans, a division of Capital Bank, N.A. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. Brian Martucci – NMLS# 185421. His opinions do not necessarily reflect the opinions and beliefs of Capital Bank Home Loans or Capital Bank. Capital Bank, N.A.- NMLS# 401599. Click here for the Capital Bank, N.A. “Privacy Policy”.​

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