APR or Total Cost?

by Tom Tousignant

in Blog, Home Buying, Mortgages, Refinancing

APR on Reg ZAPR is an acronym for Annual Percentage Rate.  It’s a government-mandated calculation meant to simplify the comparison of mortgage options.  It is probably the most misunderstood number at any closing or with any application.

A loan’s APR can always be found in the top-left corner of the Federal Truth-In-Lending Disclosure.

Because APR is expressed as a percentage, many people confuse it for the loan’s interest rate.  It’s not.  APR represents an estimate of the total cost of borrowing over the life of a loan.  “Interest rate” is the basis for monthly mortgage repayments.  APR has nothing to do with your payment.

The concept of the APR is to allows consumers to make an “apples-to-apples” comparison between loan products.

As an example, a 5.000 percent mortgage with origination points and fees will almost certainly have a higher APR than a 5.500 percent mortgage with zero fees.  In this sense, APR can help a borrower determine which loan is least costly long-term.

However, APR is not without its shortcomings.

First, different banks includes different fees into their APR calculations.  By definition, this spoils APR as a choose-between-lenders, apples-to-apples comparison method.

And, second, when calculating APR, “life of the loan” is assumed to be full-term.  When a 30-year mortgage pays off in 7 years or fewer — as most of them do — APR comparisons are rendered moot.  For Adjustable Rate Mortgages, or ARM’s, the APR has to make an assumption as to what rates will do after they adjust – an impossible task that makes APR virtually useless to compare ARM loans.

In other words, APR is just one metric to compare mortgages — it’s not the only metric.  The best way to compare your mortgage options is to review all the loan terms together and determine which is most suitable.  We do this with the Total Cost Analysis report.  The Total cost is simply the sum of the interest you will pay plus the closing costs you pay for a particular loan program.  We give all of our clients a Total Cost Report when they are looking at loan options. In fact, we can even plug in ompeting offers into our software and show the Total Cost of a competitors program.

If your Lender can’t help you calculate the Total Cost of a loan choice, ask some tough question – they are telling you that they can’t tell you the cost of the product they are selling.  Yikes! Do you really want to buy that?

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