Does the APR really show the “truth” in lending?

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The federal government requires the mortgage industry to use the Annual Percentage Rate (known as APR) for consumers to compare offers from mortgage companies. The idea behind its mandate is to provide a tool for consumers to use as an “apples to apples” way to compare loan offers. The lower the APR, the better the deal. Right?!?

Does the APR really do this? Well… I’ll defer to Tom and Jack from their “discussion” in A Few Good Men answer that question.

Well, the truth is the APR has great intentions, but it isn’t necessarily the best tool to use when evaluating loan offers. Here is why:

  1. The APR is based on fees for services to get the loan closed. If the fees are estimated low early in the process and then increase, the APR would increase. With new laws in place, lenders have to disclose if the APR increases more than 0.125% from the original documents you sign. Still, if you’ve started with a lender, you are less likely to change course later on in the process if there is a slight increase in the fees. This is one way some choose to “lower” their APR on the initial offer to make it more competitive.
  2. The APR assumes you will keep the loan for the life of the loan. For example, on a 30 year fixed mortgage, the APR shows its value over 30 years. If you payoff the loan early, sell the home, refinance, etc., the APR would then change. Since the APR could be impacted by how long you keep the mortgage, it stands to reason the APR may not be the best tool to use when trying to decide on a mortgage program.
  3. The APR is somewhat useless on particular loan programs. Since the APR is based on the life of the loan in an “fixed/ideal” situation, any attempt to hone in on an accurate APR for an adjustable rate mortgage over the life of the loan is laughable. Since ARMs can adjust (typically) up to as much as 5% higher than the initial rate over the life of the loan, how can one possibly figure an accurate APR?!? Also, many consumers choose to refinance their ARM loans prior to them adjusting, and that takes us back to the problem discussed in point #2.

The ARP is a tool for consumers to use, but it is not and should not be the deciding factor on what loan program/lender to choose. When comparing offers, always evaluate the interest rate, closing fees associated with the lender, and closing fees associated with the attorney. Those items are identified in lump sum totals on the good faith estimate.

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One Response to “Does the APR really show the “truth” in lending?”

  1. Using APR to find a “great deal” « The Mortgage Blog Says:

    […] or not APR really showed the “truth in lending.” You can see that post from my blog here. Recently I ran across a post by Dan Green from @mortgagereports. Dan is a loan officer in Ohio, […]

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