- The Washington Times - Wednesday, August 2, 2006

Q:We are under contract to purchase our first home and are in the process of

mortgage shopping. I was told that the best way to really compare mortgages is by checking the annual percentage rate. The problem is that most loan officers are unable to tell me the APR over the phone. It seems as if they’re trying to skirt the issue when I ask. They all want me to believe that the APR isn’t important. If that’s the case, then how come I’ve read that the federal Truth-in-Lending Disclosure, which displays the APR, is supposed to be so important? Please advise.

A: I’ve been at battle with the APR for years, as have most other competent loan officers. You have probably been browsing government-sponsored Web sites that espouse the myth that comparing the APR among lenders is the best way to find the lowest mortgage rate.

Nothing could be further from the truth. Let me explain.

The APR is supposed to give the consumer the ability to compare mortgage rates on an apples-to-apples basis. It is supposed to give the consumer the true cost of the mortgage expressed as an interest rate when you take into consideration any costs associated with the loan.

The APR is well-intentioned, but it just doesn’t work. I am not short on reasons as to why. Here’s a sampling:

• All transactional costs are not included when calculating the APR. Lender fees such as underwriting, document preparation, origination fees and discount points are typically included in the calculation. But appraisal fees and attorney fees, among other costs, often are excluded.

• Lenders don’t calculate the APR uniformly. The sad truth is that the APR is calculated through mortgage software. Lenders use different software, which may have slightly different programs that calculate the APR.

• The APR is calculated as a result of numbers that are fed into the program. These numbers come from the Good Faith Estimate, provided by the loan officer. If the loan officer underestimates the costs associated with obtaining the loan, his APR will be falsely low.

• One cost that is included when calculating the APR that, in my opinion, should be excluded, is prepaid interest. Prepaid interest is simply the interim interest paid at settlement for the remaining days of the month from the settlement date.

If you settle at the end of the month, the prepaid interest will only be for a day or two. But if you settle at the beginning of the month, the amount of prepaid interest will be about 30 days, which will increase the APR.

But settling at the beginning of the month means the borrower receives his loan proceeds 30 days earlier and his first payment is due 30 days later.

I’ve had arguments on this issue with other mortgage professionals. I’m staying firm: Prepaid interest shouldn’t be included when calculating the APR.

Either way, the settlement date is often not firmed up at the time of application, when the APR is disclosed, so the loan officer must guess the prepaid interest anyway.

• Federal law requires that the APR be calculated for adjustable rate mortgages, which is preposterous. How can any loan officer worth his salt sincerely tell his client an accurate APR when the note rate will change in the future to an unknown rate?

• Perhaps the biggest flaw with the APR is that it assumes that the borrower will hold the loan for the entire term. Again, this is preposterous. How many American homeowners over the last 25 or 30 years still have their original mortgage? Not many.

This is a mistake many first-time buyers make. They see that by increasing the upfront points paid to the lender, the note rate drops, as does the APR. The problem is that such a strategy can only work if the loan is held near or to full term. If he refinances, sells the property, or pays off the loan early, his actual APR would be far higher because the points paid would be amortized over a much shorter period. Likewise, the benefit of the lower note rate is cut short.

OK, I’ll get off my soapbox.

The fact is that although well-intentioned, the Department of Housing and Urban Development (HUD) did not think things through when it required lenders disclose inaccurate and misleading APR numbers.

I do have some advice. Forget the APR and ask for a Good Faith Estimate that itemizes all closing costs that are associated with the interest rate quoted.

Loan officers must estimate certain costs that are not direct lender fees, such as attorney charges, but good, honest loan officers will be happy to guarantee any lender-related fees. Insist that lender charges are guaranteed in writing.

One more thing. I have always advised that borrowers ask trusted sources such as friends and neighbors for referrals of lenders with whom they had a good experience. Reputation, good or bad, spreads like wildfire in this business, and you will probably get a better deal and better advice by going to someone who comes highly recommended.

I would be wary of the myriad of Internet and toll-free lenders touting programs that are too good to be true.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).

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