I’m looking at a consolidation loan, and under interest rate it says this:
5.875% (7.681% APR)
Now, what is the difference between the two rates?
The difference is 1.806%. Ba-dum!
OK, then. The raw interest rate (5.875%) is the rate at which interest will be charged on the principal you borrow. The APR (annual percentage rate) is the total effective rate you will be paying, including closing fees, application fees, and so forth. The APR calculation is rigidly standardized so as to prevent unscrupulous lenders from hiding what are essentially high interest payments in the form of miscellaneous fees.
ETA: Wikipedia on APR.
To emphasize, if you take this loan, you will be paying a rate of 7.681%. You can disregard the raw rate; they just put that in to try to get you to take the loan.
Regards,
Shodan
**Friedo ** nailed it in one. At your most closings you’ll be presented with what’s referred to as a Truth In Lending Statement that shows that because most people choose to finance most of the closing costs, as well as the loan itself it inflates the overall interest rate. If you can swing it, see if you can pay those fees outside of the closing so that you don’t finance them.
So basically, they are rolling any closing costs and application fees into the payments, thereby making the effective rate higher. So the 5.875% means absolutely nothing? Or do I have the option of paying the costs and fees up front and getting the lower rate?
Well, it’s the base rate. For an adjustable rate mortgage, that’s very important to know. It also helps to know when you’re comparing loans from different lenders, so you can get an idea of how much you’re being gouged with fees. (You ARE getting multiple quotes, right? Right?)
You should have that choice. Naturally, they’d rather you didn’t, so they can make more money off you in the long run.
APR is the cost of the loan; not the interest rate. The cost of a loan is the interest rate plus closing costs (application fee, appraisals, all of the good stuff they charge you on top of the loan). The 5.875% is the simple interest rate. Once you tally up the amount financed plus the closing costs, you can safely use the 5.875% to calculate your payments. Even if you pay the closing costs in cash up front, you still use the 5.875% rate, but even so, you’re still effectively paying the higher rate by virtue of having had to pay upfront costs in the first place in order to acquire the loan.
Personally, I prefer to look at the interest rate rather than the APR, and then look at the costs as a separate item when comparing loans. In the end, though, it’s really the APR that matters.
It’s not that they’re rolling the fees into the loan, it’s that the costs & fees reduce the net amount you’re actually getting. So if you get a 30 yr, $100k loan, at a rate of 5.875%, your payment will be $591.54. However, if they charge $5k in fees, you’re really only getting $95k - on closing day you hand them $5k, they hand you $100k, so you’re $95k ahead. Your payment will still be $591.54, and if you recalculate the loan assuming $95k principal, $591 payment, you get an interest rate of 6.35%, which would be the APR.
Here is a discussion of when the APR is useful and when it isn’t: Tutorial on Annual Percentage Rate (APR) - The Mortgage Professor
The explanations upthread are good, so I won’t rehash.
But, the APR gives you a basis of comparison between loans. So, the APR is really only worthwhile as a comparison to other loans; if you get one loan with lots of upfront fees, but a lower rate, it might look cheaper than if you got a loan with few upfront fees, but a higher interest rate. With the APR, you get a uniform measurement (which standardizes interest and fees) to compare the two.
Oh, and you should have an idea of what your APR is within two business days of applying for the loan. You should get a something called a “Good Faith Estimate” that gives you a reasonable approximation of what fees you’ll be expected to pay (finance) and what your APR should be.
Thanks for all of the replies…
Does the APR include ALL things like, say property tax and casualty insurance in a home, or are those extra?
In other words, I want to get down to brass tacks with the lenders and quit playing games. I want to know:
What are the terms (fixed 30, fixed 15, ARM)?
What are my monthly payments that cover EVERYTHING? Not this is your payment, but of course we have PMI, taxes, tip, mileage, etc.
Can a company give me that info up front?
Most assuredly not. Banks will all try to gage what your property tax and insurance payments are, but they’re often off the first year, especially if you live in a state where the basis is reset upon sale (such as Michigan). They’ll have a good idea of the insurance, though, since you’ll pre-pay (generally) the first year out of pocket in preparation for closing (but, if your seller is paying closing, you can be reimbursed for it [done it twice m’self]). By federal law they’re also allowed to add a percentage to these costs as a “just-in-case” for increases. Don’t worry, you don’t lose this money and it stays in escrow, but it’s still a portion of your payment.
In short, when comparing lenders, it’s probably not worth your time to compare the escrow payments. That money is still yours, and they’re limited by federal law how much the make-up amount can be. Will there be differences based on the estimates? Maybe, maybe not, but probably not significant. Keep in mind it’s not a cost; it’s still your money.
Once you have a certain amount of equity – I think the percentage is bank-by-bank, but I’m unsure – you can dispense with the lender-mandated escrow and make the payments yourself, meaning you won’t have to pay into the escrow as part of your monthly payment. Consider yourself whether this is a good idea – is the interest you lose on the escrow account worth the hassle of saving and paying yourself, or are you better off just letting the bank keep the meager interest and handling all of the details for you? On the bank’s part, it’s probably fair that they not pay interest on your escrow due to their paying your bills, as it probably costs them more to handle your bills than they make on the interest.
Note: you mention PMI – I don’t know if that’s a set price amongst all lenders, or if that’s a competitive difference, too. I’d suggest that if you have good enough credit, do an 80/20 split and ditch the PMI. The 80/20’s are “prime credit” and not part of that whole sub-prime mess.
Probably not up front since much of that information comes from third party vendors, but they should be able to estimate within 5% or so. Your APR is not going to cover escrows for taxes, insurance, HOA, etc. Those are seperate non interest bearing accounts that you establish with your lender. A good loan officer should be able to estimate you within $50 or so of your total monthly payment. Bring copies of your homeowners insurance policy (call your agent) and a copy of your most current tax bill. This will cut down on how long until they can figure out your costs.
Things like application fee, appraisal, credit report, processing fee etc. they should be able to get up front since they use the same vendors for those products all the time.