If Mortgage Rate And Fees Are Equal, Why Is One APR Higher?

July 14th, 2010

You are refinancing your mortgage, and in doing your research you have two companies from which you are getting mortgage quotes. Let’s say the mortgage rate, mortgage fees and monthly mortgage payment are the same between the two companies. So why is the Annual Percentage Rate (APR) higher on one than the other then?

With the new Good Faith Estimate (GFE) rules that took effect January 1, 2010, the ability to accurately compare mortgage quotes between companies was supposed to become easier. In fact, when comparing mortgage rate quotes, many borrowers may be more confused by the new GFE today than they were a year ago.

Loan Comparison Scenario

Let’s say that you have used a refinance calculator to determine that you can save significant money with a lower monthly mortgage payment by taking advantage of the current low refinance rates.

In checking with different mortgage companies, you find two offering the same rate and costs: a mortgage broker, and a more traditional mortgage bank. Representatives of both companies sent you GFEs showing your total charges and monthly mortgage payment to be almost identical.

However, when you receive a Truth-In-Lending disclosure from each, one APR is higher than the other. Why?

New Comparison Method

The new GFE calculation methodology required by the Department of Housing and Urban Development (HUD) skews the APR calculations of broker-originated low- or no-point loans–and makes such proposals seem worse by comparison.

Generally, the lower the upfront cost (or points) for any mortgage, the higher the interest rate, and vice-versa. Because no one works for free, low- or no-point lenders must receive their compensation from the higher rates charged to the borrower over time. This payoff can be substantial in the aggregate–but it is spread out over the loan term of typically thirty years.

However, most mortgage brokers don’t own their loans for the full thirty years until payoff; rather, such loans are sold to other entities including Fannie Mae and Freddie Mac. Thus, the loan purchaser estimates how much the loan might be worth to them over thirty years, and ‘pays’ the broker a portion of this amount upon sale of the new mortgage. Thus, rather than paying brokers directly via a point or more up front out of your pocket, you ‘pay’ for a no-point mortgage with this rebate, or yield spread premium (YSP).

Loan holders ‘pay’ their loan originator employees from the same estimates–but because it is internally credited within the company rather than between companies, the new HUD requirement does not apply.

So Why Is APR Skewed?

The reason the low- or no-point APR is higher for brokers, though the mortgage rate and origination fees may be the same, is because HUD now requires the broker to include the YSP as a charge to the borrower in the APR–but doesn’t count the later credit of the same amount in the APR. This makes it seem as though the broker is still charging upfront points, even when they are not.

You can compare quotes between low- or no-point loans and standard, upfront fee loans as follows. Simply input each example into a loan APR calculator, first with upfront points and a lower rate, and then without points but with a higher rate. You will find that the APRs are fairly close between no point/higher rate loans and standard points/standard rate loans.

When you receive a Truth-In-Lending statement for a broker-originated low- or no-point loan, the APR will still appear higher than what you have calculated–but now you have a better tool for comparison.

Calculation Example

Let’s say you have decided that the best refinance mortgage for your family is a 5.25% mortgage at no points for $275,000. A major bank’s GFE for total origination charges might be $750 (see page 1 and page 2 of the GFE in Box A: “Your Adjusted Origination Charges”).

The mortgage broker’s no-point loan offer might also have origination charges totalling only $750 for the same interest rate. However, in this example, box 1 of GFE page 2 (“Our Origination Charges”) may state $3,500, as it includes a non-existent one point origination fee. Below box 1 in box 2 you will see a check mark in a box (“You receive a credit of $2,750 for this interest rate of 5.25%”); in the right side of box 2 you will see a credit (“-$2,750.00″). In box A (“Your Adjusted Origination Charges”) the total is $3,500 – $2,750 = $750–the same as the big mortgage lender.

However, because the mortgage broker must ‘charge’ an origination fee and then credit back the APR-excluded fee, the APR on the broker’s Truth-In-Lending disclosure is skewed. The non-existent ‘origination fee’ calculates into the APR–but not the credit for the fee.

Compare APR For Yourself

When looking for the best mortgage rate for your family, use the “Your Adjusted Origination Charges” and the interest rates on your Good Faith Estimates to calculate differences between lenders using a refinance calculator; Truth-In-Lending disclosures are simply skewed in certain circumstances.

In the end, you must you accurately understand both total costs and monthly mortgage payment savings to make a decision about lenders and loan terms, when applying for a refinance mortgage.

Posted By :
Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry

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