The federal government requires mortgage lenders to disclose the “annual percentage rate” (APR) whenever they advertise a loan program. But what is APR, and does it really matter to you? Here’s the thing: APR lumps all your “finance charges” into your interest rate. As you can see from list below, some of your closing costs are considered “finance charges.” APR is calculated by adding all these finance charges to the total interest that you’ll pay over the life of the mortgage, and then calculating an annual interest rate based on that total number.
APR CLOSING COSTS & PREPAID ITEMS (FINANCE CHARGES):
- Origination Charges and Points
- Processing and Underwriting Fees
- Mortgage Insurance (monthly and upfront)
- Closing Agent Fees Retained by Mortgage Company, or Closing Fees in Excess of What You’d Be Charged if You Paid Cash
- Tax-related Service Fees
- Administrative and Wire Transfer Fees
- Pre-paid Interest
NON-APR CLOSING COSTS & PREPAID ITEMS:
- Application Fees
- Appraisal Fees
- Credit Report Fees
- Title Fees & Title Insurance
- Pest or Flood Hazard Inspection Fees
- Stamp and Transfer Taxes
- Pre-paid Escrows for Taxes and Insurance
Here are three little-known facts about APR:
#1 – ALL SELLER-PAID POINTS AND CLOSING COSTS ARE EXCLUDED FROM APR
This means that your APR will be lower if the seller is contributing funds toward your points and closing costs.
#2 – THE APR ON AN ADJUSTABLE RATE MORTGAGE (ARM) FOLLOWS A DIFFERENT FORMULA
When you have an ARM, the APR is calculated by looking at your “fully indexed rate”. This is the interest rate that you would pay if the loan adjusted today. For example, if you have a 5 or 7 year ARM, the APR on your loan is not calculated based on the rate you pay for the first 5 or 7 years of your loan. It’s based on what your interest rate would be in 5 or 7 years if the index remains the same as it is today. See Figure 2 for an example of a fully indexed rate.