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What's the APR for? Answer |
| 2. |
What is the relationship between rates and closing costs? Answer |
| 3. |
What is the difference between "closing costs" and "pre-paids"? Answer |
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Q
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What's the APR for? |
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A
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The APR is the Annual Percentage Rate, which tells nearly everyone nothing at all. The APR is meant to be a shopping tool for consumers. It's supposed to help consumers compare between competing scenarios. Such as a 5.75% loan with no fee's, and a 5.625% loan with $2,000.00 in fee's. To compare it helps to understand what is required to calculate a loan payment. There are four terms involved in calculating a loan payment: the loan amount or present value [PV], the term of the loan [N], the rate [i], and the resulting payment [pmt].
An example:
| PV |
200,000 |
| N |
360 Months |
| i |
5.625% |
| PMT |
? |
In this example the payment or PMT is $1,151.31.
To find the APR we use the same equation, but change the PV to reflect the loan amount less closing costs. In our example at 5.625% the closing costs are $2,000. What that means is that the borrower will really only receive (or net) $198,000 at closing. Since the loan minus closing costs is 198,000. The 198,000 becomes our PV, we keep the payment the same, and we now solve for i. The resultant 5.717% is our A.P.R. The competing scenario was for 5.75% with no costs. Since there is no adjustment for costs the A.P.R. is the same as the interest rate of 5.75%. Based upon the APR alone, it is better to pay $2,000 in closing costs then to take the higher rate with no costs. If the closing costs were $2,713.10, then it wouldn't matter, according to the APR, which offer you accept. The reason, both offers APR's would be 5.75%.
Is that helpful? It may or may not be, but it is required by law. The one thing the APR ignores is the "horizon" for the loan, which can change everything. One loan product doesn't fit everyone. Each should be considered in light of the over all goals the borrower has, and where the real estate fits into those goals. |
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Q
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What is the relationship between rates and closing costs? |
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A
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Rates don't change, but the cost to obtain certain rates does change. For example, on Wednesday the 8th of September 2004 our investors are offering a 5.5% 30 year loan. Some are willing to pay us a premium for such a loan in the amount of .375% or $3.75 per $1,000 we lend. Another company who is further "out of the market" is currently charging us .286% for the same rate, which means we'd have to pay them a "discount" of $2.86 per $1,000 we lend. In either case we want to make a profit, say $3,000. In the first case we'd make a loan for $300,000 at 5.5% We'll receive $1,125.00 from our investor for making such a loan, and charge the borrower $1,875.00 to make up the difference. In the second instance we'd have to pay the investor $858.00, and then charge the borrower $3,858.00 to meet our revenue requirements. Add to those charges all the other charges that we pass on from 3rd parties (title insurance, appraisal, credit reports, etc...), and the closing costs go up considerably.
Typically we offer rates slightly higher than what I describe above. The higher rates result in more of our profits being paid by the investor. The same company who had the good 5.5% rate offers 1.375% to us for loans made at 5.75% On that same $300,000.00 loan we would receive $4,125.00 from the investor, and won't charge anything directly to the borrower. Since $4,125.00 is more than our required $3,000.00 revenue we can also contribute $1,125.00 towards the closing costs paid to 3rd parties.
On our front page borrowers may note that we update the costs more often then we update the rate. This is because the market changes are so incremental that rates don't change very much. The prices do. Some days we'll display better rates with higher closing costs, and other days the rates will be higher but with lower closing costs. The reason is that the prices on the rates move slowly, and it takes a big change in price to make a difference to the rates we offer. It does not take a big change in price to change what we can contribute to closing costs. |
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Q
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What is the difference between "closing costs" and "pre-paids"? |
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A
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The key difference for the consumer is that closing costs are one time fees that occur as a result of closing. Pre-paid items are costs that you will incur on an ongoing basis.
A short list of common pre-paids includes: interest, taxes, and hazard insurance. No matter where you obtain a loan you will have to pay these items on an ongoing basis. Furthermore, these items won't differ from lender to lender. The taxes will be a function of the property you buy or own. The insurance will be a function of the insurance company you choose. Interest is the only variable that is a function of the lender you choose, because it is based upon the rate they agree to deliver.
Some lenders will try to make their estimates appear better by shortening the number of days of interest they will collect at closing. The fact is that no matter what lender you close with the number of days collected will be the same. If you are shopping, ask all the lenders to quote the same number of days of interest to prevent games from being played.
Closing costs are one time fees that are only partly a function of the lender you work with. There are lender specific fees such as: underwriting, tax service, courier fees, processing fees. Then there are fees that are deal specific fees such as origination and discount. Finally there are third-party fees: appraisal, credit reports, title insurance, recording fees, flood certifications. The lender has a lot of control over the lender specific fees and the deal specific fees, but only partial control over the third party fees. Many lenders have managed to cloak all these fees by buying into a title company or conglomerate of service producers. The purpose is to present lower fees to the borrower. The reality is the fees are still there but are paid as overhead on the backside. This can be a cost savings, but is not a panacea. Each Good Faith Estimate you obtain will disclose the total closing costs. Compare this figure and the rate offered, and you will have a clearer picture of which deal works best. |
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