Your question
points up one of the critical failures of mandatory disclosure rules in the home
loan market. Borrowers are overwhelmed with information they often don't
understand, such as the Annual Percentage Rate (APR), and critically important
information that they would understand is nowhere to be found.
Aside from the interest rate, the single
most important piece of information to a borrower is the total upfront credit
charge -- the total that the borrower must pay the lender and mortgage broker
for the loan. Yet lenders are not required to disclose it in either the Truth in
Lending Statement (TIL) mandated by the Federal Reserve, nor the Good Faith
Estimate of Settlement (GFE) required by HUD.
Why is this? The Federal Reserve requires lenders to report the APR, which is a comprehensive measure of credit
cost that takes account of the rate and most upfront credit charges. No doubt
the Fed reasoned that since the borrower knew the APR, the figure for total
credit charges that is used in calculating the APR was redundant. But it is not
redundant, because many borrowers who would understand the figure for credit
charges do not understand the APR, and are therefore reluctant to use it.
Furthermore, there is good reason for
borrowers to be leery of the APR, even if they do understand it. The APR assumes
the borrower will be in the house for the entire term of the loan, which most
are not. Borrowers who don't expect to have their mortgage for 10 years or more
can easily be led astray by the APR. In Does
the APR Help?, I give some concrete illustrations of this.
If your time horizon is shorter than 10
years, it is more useful to know the credit charges used to calculate the APR
than to know the APR itself. Using the
calculator "Estimating Lender Fees From the APR on Fixed-rate
Mortgages", you can convert the one into the other. This calculator works
backwards from the interest rate, points and APR on fixed-rate mortgages (FRMs)
to derive the other upfront fees that were used by the lender to calculate the
APR.
Here is an illustration of how it works.
My local newspaper on September 20 quoted one lender as offering a 30-year FRM
at 7.75% and 1 point, with an APR of 8.66%. Using a $100,000 loan amount, I
entered these 4 items in the calculator, clicked on the "compute"
button, and it told me that lender fees other than points amounted to $7180.
Note that APRs shown in the media assume a loan amount of $100,000 unless the
loan is designated "jumbo", in which case the assumed loan amount is
$250,000.
The fees derived from the calculator using APRs shown in the media do not include all settlement costs. Mortgage
insurance is not included in the APR until a borrower has been identified who
requires it. Settlement costs that are not viewed as part of the cost of credit
also are not included. These items include settlement/closing fees, abstract/
title search/title examination/title insurance costs, recording/filing fees, and
city/county/state taxes.
The APR calculator assumes that lenders
have properly identified all the charges that should be included in the APR, and
have calculated the APR correctly. There is a lot of anecdotal evidence to
suggest that these assumptions are not always correct. Since mistakes will
usually be in the direction of understating the APR, the user should place more
credence in high charges (such as the one cited above) than in low ones.
Copyright Jack Guttentag 2002
