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Using APR to Compare Loans

As we start a new series on Loan Mechanics: The Inner Workings of a Mortgage, the first topic is Annual Percentage Rate…APR.

When you see a loan rate advertised, you’ll also see a corresponding APR (example: Note Rate 4.5%/4.762% APR). This Annual Percentage Rate is the total cost of your loan (interest, fees and mortgage insurance) expressed as a single number over time. The purpose is to give you one number for comparing multiple loans.

But it’s an imperfect science…The problem with using APR as designed is that the calculation applies to the entire length of the loan, and most people use mortgage loans for only a few years due to refinancing or sale.

So be careful with your comparisons…Using APR for comparison can become misleading. Below, you can see the low APR option would cost over $1,500 extra if used only three years. In the fifth year, the lower APR begins to pay off with a savings of a little over $500.

APR_Chart_mortgage

Here’s a quick tip…The bigger the difference between the rate and the APR, the higher the fees. This is great to know when you see a really low rate advertised. An APR that’s anything more than a quarter of a percent or so higher than the actual rate is a sure indication that the closing fees are really adding up.

Another way of looking at this example is to ask yourself whether you prefer $3,000 of savings in the bank or a payment that’s $30 less per month. If you are more comfortable with money in the bank, lean toward lower upfront costs. If you are more comfortable with the lowest possible payment and believe you’ll use the loan for five years or more, then the lower APR alternatives start to make sense.

Bottom Line…Lenders are required to disclose APR; it’s our choice to provide this extra information so you can make a truly informed decision about what’s right for you.

Need help? Reach out, and we’ll be happy to assist.

HUD Announced an Increase in FHA Fees

Image Increased costs FHA home loans oconomowoc wisconsin wiOn 3/6/2012 HUD’s Official Announcement came out (click here to read it). The revisions/updates below are in red.

As part of HUD’s ongoing efforts to increase their financial health – and to get the FHA back into a place where they meet their capital requirements – on Monday, HUD announced the anticipated increases in the premiums they charge borrowers for FHA loans.

In its simplest form: The cost of borrowing is going to rise.

As you might know, the standard FHA loans are less risk-sensitive with their underwriting guidelines relative to conventional loans (that means lower credit score requirements, less money down, higher debt-to-income ratios, etc.). FHA is not a lender. Instead, they are a federally-backed insurance company that insures lenders against default on loans that are in compliance with their published guidelines.  A PMI company would be a private equivalent of the FHA. It is because of this insurance that lenders approve and close loans with more liberal guidelines; without it, the loans could not be closed.

As a federally-backed insurer, the government charges two types of premiums on the FHA mortgages:

  • Monthly Mortgage Insurance Premium (UFMIP) This, too, will increase. It will go up 10 basis points (0.1% per year) on April 1, 2012 for all cases assigned on or after April 9, 2012 to cover the requirements of the payroll tax extension approved in December of 2011. You might recall that this was already tacked on to conventional loans from a post I wrote a while back. This is a direct increase of 10 basis points (0.1%) in the borrower’s mortgage payment. For those in very high cost areas, FHA loans over $625,000 will be bumped 35 basis points from today’s levels effective June 1, 2012 for all cases assigned on or after June 11, 2012.
  • Up Front Mortgage Insurance Premium (UFMIP) This fee will, effective April 1, 2012 for all FHA cases assigned on or after April 9, 2012, go from its current 1% to 1.75% of the loan amount. One huge advantage to this UFMIP is that it is customarily built into the loan and does not require additional cash from a buyer at closing. That increase, however, certainly does impact monthly payment and cash flow.

Bottom Line:

  • If you are selling a home, get it priced correctly and under contract this month.
  • If you are buying a home, it’s quite possible that right now is the time where the cheapest possible mortgage is available – ever.  It’s time to make that to get yourself into a home!

To find out how this impacts you directly, please contact me directly for a completely free consultation.