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
