:
(From the
Note)
Amount of
Loan
Years
Interest
Rate
(From the
Settlement Statement)
Points
paid
Closing
costs
By using the
BankSite.com APR calculator and reading the explanation and examples below,
an NSA may get more comfortable with the term “APR.” Other tools and links for
the purpose of this article can be found at these links:
Discussion and Examples
To arrive at an understanding of how the APR
differs from the rate in the note, it will be better to show it through
examples. To that end, we are going to set up a couple of examples and
imaginary lenders.
In Example #1, we are going to gather the
information needed to calculate the APR, and explain how it is calculated.
Later, this example will be referred to in a comparison of mortgage loans.
Next, we will discuss why there is an APR
formula, then cover what would happen if only the rate in a note were all
that a borrower considered when choosing a lender to refinance a mortgage loan.
Then, we will set up Example #2 – Lender #2,
arrive at the APR from that loan, then conclude this article by comparing the
two examples and the two lenders’ loans and terms.
Example
#1 – Lender #1
For the
purpose of discussion, we will call this Example #1 and will say it is offered
by "Lender #1." We will get the finance charges by using the interest rate in
the Note, loan amount, and the amortization of the interest charges over the
number of years the amount is financed for.
We will get
the Points Buy Down and Closing Costs from an imaginary HUD-1 Settlement
Statement which an NSA would presumably be able to refer to.
In Example
#1, let’s say the loan is for $60,000, for 30 years, at 5.2 percent (Fixed).
Also, let’s
say that the Borrower’s miscellaneous closing costs are
$4200 and they will pay 2 points (2%
of the loan amount which is $1200).
The total upfront closing costs are now:
$5400.
The monthly
payment is calculated to be $329.47, as stated in the Note, over the life of the
loan which is 30 years.
Based upon
the amounts stated above, if you plug this information into the
BankSite.com calculator you will see that the APR is 5.984%.
If the
BankSite.com calculator is not available to the reader, perhaps the APR
calculation of these factors explained in Example #1 will help reveal the method
used to arrive at the rate of 5.98%. (For our purposes, we will assume we have
a Note and HUD-1 Settlement Statement to refer to, and that the Notes are at a
fixed rate.)
On Side “A”
is the information that is stated in the Note. The only
costs of the loan that can be
calculated from the information in the Note are interest or finance charges.
(To
get interest or finance charges, if you do not have an amortization calculator,
but you do have a note to look at, you can take the total amount of the monthly
payment stated in the Note, multiply it by the number of payments which will be
made and get the total. From the total, subtract the loan amount and that will
be the total amount of interest or finance charges.
All tools
used to arrive at the amounts in Example #1 are in the links at the end of this
article.)
On Side “B”
is the information which can be collected from the Note and HUD-1 Settlement
Statement. From this side of Example #1 a true picture of all costs of the loan
will be revealed which includes not only interest charges, but also the closing
costs of the loan. When all of these costs are available, an APR can be
calculated.
|
Example #1 –
Lender #1:
|
A
|
B
|
|
Closing Costs – not stated |
UNKNOWN |
Closing Costs |
$4200 |
|
Points Paid – not stated |
UNKNOWN |
Points Paid |
$1200 |
|
Total Closing Costs |
UNKNOWN |
Total Closing Costs |
$5400 |
|
Loan Amount |
$60,000 |
Loan Amount |
$60,000 |
|
Note Loan Amount
plus closing
costs which is |
UNKNOWN |
Note Loan Amount
plus closing
costs which is: |
$65,400 |
|
Length |
30 years |
Length |
30 years |
|
Monthly Payment:
|
$329.47
|
Monthly Payment
(from Note):
|
$329.47
|
|
Total
Interest charges
can be calculated to be in the amount of:
|
$58,609.20 |
Total
Interest charges
can be calculated to be in the amount of (Using the Note):
|
$58,609.20 |
|
Total Payments will be |
$118,609.20 |
Total Payments will be |
$118,609.20 |
|
Stated Rate on note is: |
5.2 % |
Stated Rate on note is: |
5.2 % |
|
ALL
costs of the loan
(Finance Charges +Total Closing Costs) is |
UNKNOWN |
ALL
costs of the loan (Finance Charges + Total
Closing Costs) is |
$64,009.20 |
|
Formula
For
Calculating
The APR: |
NOW, to
get the APR which will reflect all the costs of the loan,
(1) Take the loan amount,
plus the closing costs which is $65400.00 loaned at 5.2%
for 30 years. This will produce a monthly payment of:
$359.41 |
|
|
|
(2) Then, you go “backwards”
by starting with the payment of
$359.41 on a loan of $60000.00 at 30 years which
would provide |
|
|
|
a rate of: |
5.984 %
(APR) |
|
Why
do this?
Because this gives lenders a
truthful way to state, or report, an
all-inclusive total of the note interest rate PLUS closing costs through a
formula which results in an APR rate.
The APR is standardized and can be used to
fully compare one lender’s loan to another lender’s loan.
Without the APR method of looking at loan
costs, it is impossible to see the best loan available, or to report the costs
of a lender’s loans in a comparable method.
If
lenders stated and reported loan rates at a
note rate of 5.2 percent
interest; the 5.2% rate might
look like a great deal at first glance in comparison
to another lender’s rate of 5.5%. However, the rate on the note will not
reflect the closing cost information or the 2 point buy down which is
required.
Without
charges other than finances charges disclosed, the loan’s true cost is not
reflected.
APR
for Comparing Loans
When
comparing loans to determine which one is a better deal, if only the Note
Interest Rate is considered, the information needed to analyze and compare loans
will not be complete.
Here is a
very elementary comparison of two loans:
Lender #1
quotes the Note Interest Rate at 5.2%,
and we’ll use the example costs and rates in Example #1 above.
Lender #2 is
quoting the Note Interest Rate at 5.5%
and we’ll use the example costs and rates in Example #2 below.
At first
glance at the Note Interest Rate, it appears that Lender #1 is the winning bid
for the cheaper loan.
However, the
Note Interest Rate does not disclose the
total costs of the loan.
From Example
#1, we can see that the total cost of a loan is the amount of
Finance
Charges (Interest)
+ Points Buy Down +
Closing Costs.
In this
situation, Lender #1 is lending the money at the Note Rate of 5.2 %. However,
remember that Lender #1 also required a 2-point buy down ($1200) and an
additional $4200.00 in closing costs.
To know how
to equally compare Lender #1 and Lender #2, we have to determine all the costs
on the loan offered by Lender #2. For the sake of discussion and making this
easy to come to an understanding the difference of the rate stated in the Note
and the APR, we will say that Lender #2 is charging no points, and closing costs
will be no more than $1200.
What we will
conclude is Lender #2 is offering a loan of a 5.5% Note Interest Rate which will
produce an APR of 5.6803% given
all the other costs of the loan factored into the formula.
On the other
hand, Lender #1, who is quoting 5.2 % rate of finance charges in the note has
higher closing costs. And, when we calculated finance charges plus the
other costs of this loan, the APR is 5.9841%.
In
the final analysis, Lender #1’s loan has a cost which is
higher than that of Lender #2.
Using the same way of
analyzing Lender #2’s loan as we did in Example #1, here is how it will break
down:
|
Example #2 –
Lender #2
|
A
|
B
|
|
Closing Costs – not stated |
UNKNOWN |
Closing Costs |
$1200 |
|
Points Paid – not stated |
UNKNOWN |
Points Paid |
$0 |
|
Total Closing Costs |
UNKNOWN |
Total Closing Costs |
$1200 |
|
Loan Amount |
$60,000 |
Loan Amount |
$60,000 |
|
Note Loan Amount
plus closing
costs which is |
UNKNOWN |
Note Loan Amount
plus closing
costs which is: |
$61,200 |
|
Length |
30 years |
Length |
30 years |
|
Monthly Payment:
|
$340.67
|
Monthly Payment
(from Note):
|
$340.67
|
|
Total
Interest charges
can be calculated to be in the amount of:
|
$62,641.20 |
Total
Interest charges
can be calculated to be in the amount of (Using the Note):
|
$62,641.20 |
|
Total Payments will be |
$122,614.20 |
Total Payments will be |
$122,614.20 |
|
Stated Rate on note is: |
5.5 % |
Stated Rate on note is: |
5.5 % |
|
ALL
costs of the loan
(Finance Charges +Total Closing Costs) is |
UNKNOWN |
ALL
costs of the loan (Finance Charges + Total
Closing Costs) is |
$63,841.20 |
|
Formula
For
Calculating
The APR: |
NOW, to
get the APR which will reflect all the costs of the loan,
(1) Take the loan amount,
plus the closing costs which is $61,200.00 loaned at 5.5%
for 30 years. This will produce a monthly payment of:
$347.49 |
|
|
|
(2) Then, you go “backwards”
by starting with the payment of
$ 347.49 on a loan of $60000.00 at 30 years
which would provide |
|
|
|
a rate of: |
5.6803%
(APR) |
|
A
final comparison to see the difference in actual costs of the loans when
considering all factors used to compute APR:
|
|
Lender #1 |
Lender #2 |
|
|
Loan
Amount |
$60,000 |
$60,000 |
|
|
Note
Interest Rate |
5.2% |
5.5% |
|
|
Monthly Payments |
$329.47 |
$340.67 |
|
|
Total
Payments over 30 years |
$118,609.20 |
$122,614.20 |
|
|
Total
Finance Charges |
$58,609.20 |
$62,641.20 |
|
|
Total
Closing Costs |
$4500.00 |
$1200.00 |
|
|
Total Loan Costs, not
including the principal amount |
$64,009.20 |
$63,841.20 |
ß
Difference in Cost:
$168.00 |
|
APR |
5.984 %
|
5.6803% |
ß
Difference in
APR:
0.3% |
For tools and more reading
on APR, I would recommend:
