You may have heard the terms “APR” and “Truth-in-Lending,” but what exactly do these concepts mean? And how does this information apply to you as a consumer and borrower?
The Truth-in-Lending Act
The Truth-in-Lending Act (TILA) is one of the most critically important consumer protection acts in the mortgage business. In order to protect consumers, it requires complete disclosure of all credit terms, the consumer costs of obtaining credit, and the rules that will protect consumers when they borrow using a home as collateral.
Truth-in-Lending regulation has a noble purpose. It is designed to allow the borrower to comparison shop loan programs and the overall cost of credit while providing protection from inaccurate and unfair advertising. Unlike the “Good Faith Estimate” which discloses the entire transaction’s cost, Truth-in-Lending deals only with the cost of the loan. TILA was created for the following purposes:
- To protect consumers by requiring the disclosure of all costs and terms of credit
- To create uniform standards for stating the cost of credit, thereby encouraging consumers to compare the costs of loans offered by different creditors
- To ensure that advertising for credit is truthful and not misleading
The Truth-In-Lending Disclosure Statement (TIL) should be given to the consumer at the time of application. If it is not, the lender has three business days from the date of application to mail the disclosure to the borrower.
The Annual Percentage Rate (APR)
One of the most important figures disclosed on the TIL is the APR. The APR calculation may confuse the lenders and buyers alike. “Annual percentage rate” sounds a lot like “interest rate” to most borrowers. The APR is not an interest rate, but a theoretical measure of the cost of credit expressed as a percentage rate. The purpose of the APR is to provide consumers with a uniform measure of the cost of a loan. The APR equation includes the contract interest rate and adds the costs of the loan, including any prepaid costs (points, fees, etc.) that are part of the cost of borrowing. Ideally, borrowers can compare costs from company to company by comparing the APR.
ANNUAL PERCENTAGE RATE
TOTAL OF PAYMENTS
The cost of your credit as a yearly rate
The dollar amount the credit will cost you
The amount of credit provided to you or on your behalf
The amount you will have paid after you have made all payments as scheduled
The APR Formula:
1) Compute total of payment by multiplying payment schedule, including PMI by amount of payments.
2) Amount Financed is the loan amount, less points, prepaid interest, PMI, and lender fees
3) Finance Charge is the Total of Payments less the Amount Financed
4) Compute the APR by dividing the Total of Payments by the number of payments and apply that against the Amount Financed, as if it were the loan amount
The first step in determining an APR is to subtract the prepaid finance charges from the loan amount. The result is the “amount financed.” Next, the full principal and interest payment (including Private Mortgage Insurance or PMI ) is applied against the “amount financed” as if it were the loan amount. The resulting interest rate is the APR.
What are Finance Charges?
A prepaid finance charge is any charge one must pay in exchange for obtaining a loan (charges you would not incur if you were paying cash for the property). Like the APR, it can be used by consumers as appoint of comparison between lenders. Finance charges include loan fees (discount points, origination few, PMI) and miscellaneous fees (tax service, underwriting, document preparation, or lender review few).
In addition, some prepaid items such as per diem interest and escrows for PMI or prepaid PMI, FHA upfront MIP (Mortgage Insurance Premium), and the VA (Veteran’s Administration) funding fee are considered finance charges. Other prepaid items, such as association dues, are not included.
Appraisal and credit report fees are not included when they are collected as part of an application fee. Any inspections (termite, well, septic, etc.) that are required by lenders are not considered finance charges. Fees for recording a deed of trust are not included either. The only exception is a construction loan draw inspection.
There are a number of third party fees involved with the finance charge; Regulation Z (12 CFR 226.4(b).) lists the following charges from third parties as examples of fees that the creditor must include when calculating the finance charge:
- Interest, time-price differential, and any amount payable under an add-on or discount system of additional charge
- Service, transaction, activity, and carrying charges
- Points, loan fees, assumption fees, finder’s fees, and similar charges
- Investigation and credit report fees
- Premiums on insurance protecting the creditor against the consumer’s default
- Charges imposed on a creditor by another person for purchasing or accepting a consumer’s obligation
- Premiums or other charges for credit life, accident, health, or loss-of-income insurance, written in connection with a credit transaction
- Premiums for homeowner and liability insurance written in connection with a credit transaction
- Discounts to induce payment by a means other than the use of credit
- Debt cancellation fees
There are also a number of fees that are excluded from the finance charge:
- Application fees charged to all applicants for credit
- Charges for unanticipated late payments, exceeding a credit limit, or delinquency
- Charges imposed by a financial institution for paying items that overdraw an account
- Fees charged for participation in a credit plan, whether assessed on an annual or other periodic basis
- Seller’s points
- Interest forfeited as a result of an interest reduction required by law on a time deposit used as security for an extension of credit
- Real-estate related fees such as fees for title examination, charges for the preparation of loan documents, credit report fee, notary fees, appraisal fees, and amounts paid into escrow, if these fees are bona fide and reasonable
- Discounts offered to induce payment by cash, check, or other means
Insurance and debt cancellation coverage can also be excluded if the coverage is not required by the creditor, the premium for the initial term of insurance is disclosed, and the consumer signs or initials a written request for the insurance. If itemized and disclosed, certain taxes and fees prescribed by law are also excluded from the finance charge.
Explaining the amount financed would be much simpler if each loan came with an “itemization of amount financed.” The itemization would include a detailed list of the loan amount, the payment schedule, and each finance charge.
Another factor in calculating your APR is the payment schedule. To determine the payment amount to apply against the amount financed, divide the total of payments by the number of payments and use this average amount. On a fixed-rate loan, the payment schedule is quite simple-the monthly payment is the same through the life of the loan. Variable payments (as in an ARM, Buydown, GEM, or GPM) may be more complicated on a payment schedule. The APR or ARMs can change based upon future interest rate changes. Buydowns, GPMs, and GEMs have fixed payment schedules, so the APR on these loans will not change.
After the APR, amount financed, and total of payments have all been calculated, what is the total finance charge? The difference between the total of payments and the amount financed represents the cumulative total of all interest and prepaid finance charges accrued on the loan, or the total finance charge. Subtracting the amount financed from the total of payments reveals this number.
Call us at 805.543.LOAN to talk to a loan officer if you have any questions about TIL or APR. The Mortgage Experts are here to help!
Central Coast Lending is a California mortgage broker and direct lender based on the Central Coast of California in San Luis Obispo County. Call 805.543.LOAN to set up a free pre-qualification.
One of the most misunderstood parts of the mortgage process is the pricing. In this guide, we attempt to clearly (and quickly) explain how the mortgage pricing works.
There are two main types of payments that the borrower will make.
Under new government regulation, loan officers charge a fixed percentage for any loan, which is commonly referred to as “points.” This charge is fixed prior to each loan and the process is very transparent. Central Coast Lending has one of the lowest charges in the industry (for more on our pricing, call 805.543.LOAN).
- Points refer to the percentage paid by the borrower for the mortgage rate. For example, “1 point” corresponds to a cost of 1% of the total loan amount. For a loan valuing $417,000, this would translate to a $4,170 payment (for 1 point).
The other component of closing costs refers to charges for items like the appraisal, the escrow process, and a handful of other costs. Combined with the payment to the loan officer, this handful of charges amount to your “closing costs.”
In addition to the “closing costs” mentioned above, every mortgage rate has a “rate cost” associated with it.
- The 30-year fixed mortgage, for example, will have a handful of rates available, such as 3.000%, 3.125%, 3.250%, 3.375%, and so on.
- Just like for goods in a supermarket, each mortgage rate has a “cost.”
- This cost is also expressed as a percentage of the total loan amount.
- The actual price paid for a mortgage rate varies on a sliding on a scale from “cost” (you pay) to “rebate” (lender pays).
The “rate cost” ranges from paying “points” for the loan, or receiving a “rebate” to go towards paying your closing cost. Sometimes the option is cost-neutral, or “par”.
Rate costs very based on each lender. As a mortgage broker, this gives us a competitive advantage – it allows us to shop around lenders to find the best rate and term that works for you.
Central Coast Lending will help you find the right mortgage/cost combination for your finances.
Once you combine the net “closing cost” and the net “rate cost” you get your final “points” payment for the mortgage closing.
When we write that “rates improve”, we are referring to the “rate cost” (by the lender) that is moving, which is reflected in a lower APR.
Questions? For more information, please don’t hesitate to call (805.543.LOAN) or email us here for a free, confidential discussion about your finances and mortgage rate pricing.
We are in a new time of loan processing. In years past lenders required less documentation, allowed for substitutions of required forms, and readily made exceptions. Today, we find that lenders are the exact opposite – lenders require fully documented files and rarely make exceptions. Following are few tips to avoid documentation troubles. Read more
Have you ever had somebody snap at you: “if you aren’t part of the solution, you are part of the problem!”? This could happen when your spouse asks you to mow the lawn, and instead you decide to remodel the landscaping, beginning by ripping up the grass in its entirety.
Part of the mortgage qualification process involves credit score. Loan programs have minimum credit score guidelines, and your credit can affect the interest rate you are able to obtain. An ideal situation will have a strong credit score, but we realize that every borrower has unique circumstances. If you find yourself needing to rebuild your credit score, check out this handy guide I put together. Read more
Lending ain’t easy. Lately, we have seen tightened lending standards and an increasingly rigorous loan process. In our quest to make every transaction as quick and painless as possible, we decided to address these difficulties as part of an ongoing series called “Lending a Hand.” This series will prime you the challenges you might encounter during the loan process. Today’s article: The Floating Rate Lock.
Lending ain’t easy. Lately, we have seen tightened lending standards and an increasingly rigorous loan process. In our quest to make every transaction as quick and painless as possible, we decided to address these difficulties as part of an ongoing series called “Lending a Hand.” This series will prime you the challenges you might encounter during the loan process. Today’s article: Rate Locks.
An average rate sheet will have ten or so rates listed on it and next to those rates will be an associated cost or rebate (money the bank is willing to pay for closing cost etc.). In other words, the lower the rate, the higher the cost, and the higher the rate, the lower the cost. A good deal of the recent regulation aimed at the mortgage industry as a whole is meant to specifically make sure that clients are aware of these options.
Which rate you choose, particularly on a refinance that will not require that you come out of pocket with money, should be a mathematical decision based upon the likelihood that you will still own the house and be in the loan at the point where you see financial benefit from the lower monthly interest cost. It is relatively simple to figure out the break even point on each rate and set of closing cost. On a purchase people are often limited by the cash they have on hand. Still the use of those funds is something that everyone should examine closely on every transaction to insure that they are maximizing the use of their money with in their time frames.
On our recent January 14 Mortgage Matters show, we welcomed Dan O’Hare from GBP&B Public Accountants on the show and we got to talking about tax credits. Below, Dan follows up with a question about a “roof tax credit.”
“The roof tax credit does exist and it falls under the Personal Energy Property Credit rules and is claimed on IRS Form 5695. The credit is limited to 10 percent of the cost up to $500 of metal roofs with appropriate pigmented coatings and asphalt roofs with appropriate cooling granules that meet ENERGY STAR requirements. Note that installation costs do not count towards the cost.”
You can see Dan O’Hare’s profile HERE.
In his weekly column, Central Coast Lending co-owner and broker Jason Grote takes a look at refinance and uses an example to expand on the question – when does it make sense to refinance? Jason explores the idea that it could make the most sense to lower your rate term and increase your monthly payment.