Builder & Remodelor, September 2004 By Michele Francis

As I mentioned in a previous column describing Good Faith Estimates (GFE’s), it is very important for home buyers and refinancers to make sure that lenders are providing them with all required disclosures and then to scrutinize those disclosures carefully. The federal Truth in Lending Act (TILA) statement is one such disclosure that, like the GFE, lenders are required to provide to an applicant within three days of receiving an application.

The TILA statement is a comprehensive document whose purpose is to consolidate all of the terms and conditions of the relevant loan program, including interest rate, total amount being financed, an amortization schedule, fees and points incurred, prepayment penalties if applicable, and, perhaps most importantly, the annual percentage rate (APR).
Of course, such a detailed document can and will generate a level of confusion about any of the topics it covers. Let us focus on the topic that usually prompts buyers to pick up the phone and ask for an explanation – annual percentage rate.

The purpose of the APR is to assist borrowers in comparing “apples to apples.” Consider the home buyer who needs a mortgage loan and, during the shopping process, is quoted rates of 5.25% and 6% by competing lenders. This would seem like a no brainer to many who reflexively sign for the lower rate. But a careful examination of the TILA statements should demonstrate the validity of the adage that “if an offer sounds too good to be true, it is.” How? Because when shopping for the right mortgage, the interest rate is not the only factor to consider. The APR measures not only the interest rate but also any other fees and points that the borrower will pay to secure the loan.

Unless the mortgage shopper faced with the these disparate rates notices that the APR for the loan quoted at 5.25% is dramatically lower than the APR for the 6% loan, then the right choice is not so obvious after all. What is really being offered is a loan with an interest rate of 5.25% and the borrower paying extra fees at the closing table. The loan being offered at a 6% interest rate has considerably less fees attached. By comparing the APR’s, the borrower should understand that one loan is not necessarily better than the other.

It is important to remember that the APR is calculated on the assumption that the loan will reach full amortization. In other words, an APR for a 30 year, fixed rate loan is most accurate if the borrower keeps the house for 30 years without refinancing. That scenario, however, is becoming less common as low interest rates have triggered refinances and buyers staying in their first homes an average of only 7 years.

A good mortgage broker will explain the APR that is listed on the Truth in Lending Act statement. As always, however, a borrower’s plans will dictate what the appropriate loan program should be. Simply comparing APR’s is not the answer. A good rule of thumb is that the APR is a more effective tool if the buyer plans on keeping the house for at least 10 years. Those with more short term plans should carefully consider the upfront fees charged to secure the enticing interest rate and determine if they will keep the house long enough to recoup the costs.

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