Understanding Interest Rate and APR is Critical

It is vital to understand the differnce between "Interest Rate" and "APR" when shopping for a home loan. We partner with CNBC contributor Barry Habib who offers excellent guidance to assist you in understanding these terms.

A borrower who is shopping for the best mortgage rate can easily be seduced by low rate offers that are accompanied by low Annual Percentage Rates (APR). Federal Law requires that APR be disclosed along side the actual interest rate…this is in order to help borrowers make a more informed decision on their mortgage. The truth is that APR is a very poor way to comparison shop for a mortgage and can cause borrowers to make costly wrong decisions.

APR was created in order to provide a way for borrowers to account for costs associated with the mortgage. This sounds good because it may not be very easy to choose between a loan with a lower rate and higher fees or a loan at a higher rate and low fees. The problem is that the APR calculation makes some very bad assumptions. First, APR assumes zero inflation and that the value or buying power of a Dollar today will be exactly equal to the value of a Dollar 10, 20 even 30 years from now. Next, the APR calculation assumes that the mortgage will never be prepaid or paid off. That means no refinancing or selling the home…highly unlikely since the average life of a home mortgage loan is less than four years. Just think, about your own clients. Is it not rare to see the same loan in place for even 5-years…forget 30-years. The APR calculation does not consider the value of the money used for fees. So if you spent thousands of dollars in points or fees to get a lower rate, the APR calculation does not give any value to the money if it were not spent on closing costs. Finally, APR does not take tax consequences into consideration. This can be significant since higher fees on the mortgage may not be deductible while the higher interest rate typically is deductible. Moreover, APR can be manipulated, making it totally worthless.

So how does APR work anyway? I like to explain it to my clients by using triangles. I often draw two sets of triangle for my clients to illustrate the difference between Interest Rate and APR. The reason for the triangle is because there are 3 sources of input…"Interest Rate", "Mortgage Amount" and "Monthly Payment". If you know any two of the three, you can calculate the third. See the triangle below.

Since any two of the three variables allows you to calculate the third, a $911 monthly payment for a $150,000 mortgage calculates to an interest rate of 6.125%. But the APR calculation uses different information. The APR calculation only keeps the "Monthly Payment" information the same. Instead of the "Mortgage Amount", APR uses "Amount Financed". This is the "Amount Financed" information on the Truth in Lending statement. Amount Financed takes into consideration the fees that are lender imposed. This includes application fees, points, commitment fees…and interim or per diem interest. So, Amount Financed is the mortgage amount less any lender fees, points and interim interest. The more fees, the lower the Amount Financed. The monthly payment is then calculated as a product of the Amount Financed to give you the "Annual Percentage Rate" or "APR". So the lower the "Amount Financed", the higher the "APR" is. Amount Financed can be manipulated by assuming a closing on the last day instead of the first day of the month. That would increase the Amount Financed and decrease the APR.

Here is a real example on a $150,000 fixed rate 30-year mortgage with zero points: Lender "A" (triangle above) is offering a great low rate of 5.875% and lender "B" (triangle below) is offering a higher rate of 6.125%.

A closer look shows that Lender "A" is charging $3,000 more in fees than Lender "B". How do you compare? If you look at APR, Lender "A" (5.875% with $3,000 higher fees) has an APR of 6.149%. Lender "B" (6.125% but a $3,000 savings in fees) has an APR of 6.211%. So according the APR, Lender A is a better deal even though the fees are $3,000 higher…this is exactly what these high fee lenders are hoping you look at.

Let's look at the real story. The payment difference between the two is $24 per month. So is it worth paying $3,000 in fees to Lender A in order to save $24 per month? Hardly. It will take 10.5 years for a borrower to just to get back their investment! A bad choice when you consider that mortgage loans typically are retired within four years. To make the decision to go with Lender "A" even worse, if that's possible, borrowers rarely take the value of today's dollars into account. Rather than giving Lender "A" the windfall of your hard earned $3,000, you should give it to yourself. Reduce the loan balance on your mortgage by the fees you are saving. In the example above that would reduce the loan from $150,000 to $147,000. This makes the payment difference just $6 per month instead of $24 per month! The true time to break even is really 500 months (more than 40-years!). So it is impossible to benefit from the higher fee program from Lender "A" because the maximum period on the loan is 30 years or 360 months. One more thing…when you calculate your tax deduction on the payment difference, it makes even more sense to avoid paying higher non deductible fees. The obvious correct choice is to go with Lender "B" even though the APR is lower with Lender "A".

Bottom line - You should forget APR and think twice about those advertised low rates when they are accompanied by higher fees. Use the above illustrations to help you determine the true cost of a loan being offered to you.

Is the Arapahoe County Treasurer-Elect Pulling the Wool?

Is it just me or is the newly elected Arapahoe County Treasurer trying to pull the wool over our eyes? Perhaps he already has. Doug Milliken won the job of county treasurer by approximately 2000 votes; running on a platform which touted his background as a finance expert and promising to “educate residents to make wise decisions to avoid foreclosure” and “Empower you about ways to retrieve a home out of foreclosure” Both of these statements appear on his website www.dougmilliken.com as goals and objectives.

Although honorable, I am not sure that Mr. Milliken understands his subject and therefore certain aspects of his new job. As reported in both Denver newspapers, Mr. Milliken himself is facing a foreclosure sale of his personal residence on January 3rd. In my role as a mortgage banker, I speak to individuals facing foreclosure frequently and I am not judging Mr. Milliken or the circumstances he is facing in his personal life. I am calling into question his ability to serve the citizens in Arapahoe County due to his lack of understanding of the foreclosure process and his competence to fulfill his role as treasurer.

In response to questions that have been raised by the media and Bernie Ciazza, the outgoing treasurer, Mr. Milliken has made two statements that are incorrect and are either honest mistakes concerning the facts, which underscores my point, or intentionally false, which of coarse should be of concern to the citizens of Arapahoe County.

First, Mr. Milliken claims that he was unaware that his home was in foreclosure. This is highly unlikely as the foreclosure process is mandated by statute and certain notifications must be made to the homeowner as the process moves toward resolution. Beyond the formal foreclosure process, homeowners are inundated with unsolicited offers from mortgage brokers, Realtors, and investors once the Notice of Election and Demand is filed with the County and the foreclosure is thereby made public. It is hard to accept that any homeowner could be in default for months and not be aware of the collection efforts being undertaken from the mortgage lender.

Secondly, Mr. Milliken claims that his mortgage insurance company is resolving past due payments on his behalf, which is not the purpose of mortgage insurance and further illustrates his lack of understanding. Mortgage insurance is placed on loans that exceed a certain loan to value ratio and the policy protects that lender in the event of default, not the homeowner. Further these policies do not make monthly mortgage payments on the homeowners’ behalf, they cover the shortfall for the lender as a result of a default sale of the property.

We should expect and deserve accountability from our public officials. Mr. Milliken has not demonstrated sound judgment or accountability in addressing what many consider to be legitimate concerns about his capacity to serve.

Should You Leverage The Equity In Your Home or Pay Off Your Mortgage Rapidly?

There is a great debate within the inner-mortgage circles these days. Should we, as loan professionals, encourage clients to borrow as much money as possible? Or would consumers benefit more if we helped them to understand the advantages of 15-year amortization schedules and pre-paying principal? Let's examine the pros and cons of both strategies.

Leveraging Your Property. In order to understand why you'd want to borrow as much as possible for your home purchase, you must first grasp the concept that equity has a zero rate of return. Here's an example:

If Consumer "A" buys a home for $300,000, and puts 20% down, then they have $60,000 in equity. Over the next 5 years, the property appreciates $100,000 in value. Consumer "A" now has $160,000 in equity.

Consumer "B" buys a home for $300,000, and puts no money down. At the end of 5 years, that same home is now worth $400,000. Consumer "B" has $100,000 in equity, which is the same appreciation as Consumer "A", a net $100,000.

As you can see, your down payment has nothing to do with your rate of return. What becomes important is how you choose to manage the $60,000 you didn't use as a down payment. If you use it for frivolous activities, such as buying toys or going to Las Vegas, it would be more prudent for you to use that money as a down payment. Especially since this will enable you to obtain a lower interest rate.

However, if you were to invest the $60,000 in a vehicle that can out-earn the cost of that debt, then this could be a formula for success. This is why some lending professionals suggest putting as little down as you possibly can, maximizing your tax write-off, and investing the rest. This principle has been applied for many years in the life insurance game. The old saying goes, "Buy term and invest the rest." The key component is taking the money you would have used as a down payment and creating an asset accumulation account. This account should earn a significant enough rate of return to enable you to pay your mortgage off entirely and achieve the ultimate goal of being debt-free.

Paying Your Home Down Rapidly. There are very few times over the course of my career that I have seen a client with zero debt and no financial difficulties. Choosing to pay off all of your debt can reduce stress and help you to gain freedom of cash flow for investment opportunities. A 15-year mortgage or a bi-weekly payment strategy provides structure. It can also put you on track to have your mortgage paid off within a set timeframe. Simply put, it contains built-in discipline.

It's important; however, to understand that regardless of how rapidly you pay your home off, you're not getting any greater rate of return on your investment than if you paid it off slowly.

So how does one determine which scenario is best? The choice depends entirely upon the individual. Savvy consumers who are disciplined, and are comfortable taking chances from an investment perspective, would do well with the first scenario. Over the course of time, it's been proven that your rate of return over the long-haul will be far greater than the rate you'd pay for a mortgage in today's rate environment. It's important to seek the advice of a skilled investment advisor to ensure success with this strategy.

The second scenario is best for those who have a difficult time managing their money or who'll sleep easier at night knowing they have a plan in place to pay their loan off more rapidly. Be sure that your budget can handle accelerated payments. When consumers "bite off more than they can chew" with a 15-year mortgage, they frequently end up having to refinance back into a 30-year schedule.

If you find this subject intriguing and would like to know more, I recommend that you read a book titled, Missed Fortune 101, by Douglas Andrew. It's an outstanding read that is very simplistic and goes into far greater detail than I can cover in this column. Douglas is a financial planner who advises safe-structured investments such as whole life policies and tax-free fixed income instruments.

To ensure that you have the most cost effective mortgage program and one that maximizes your ability to create long-term wealth, consult a professional mortgage banker; preferably one who carries the CML designation from the Colorado Mortgage Lenders Association. Utilizing a CML designated banker will ensure that you are being consulted by a professional committed to continuing education and who is held to the highest professional standards in the industry.

Renters Have Much to Gain by Pursuing Home Ownership

Buying a home vs. renting is a big decision that takes careful consideration, as most mortgage consultants will agree. But the benefits of home ownership usually out weigh the potential challenges to making this part of the American dream a reality for renters. Purchasing a home is the first stage in creating long-term wealth and financial security; it is an achievement that offers a sense of pride and financial stability.

The numbers are staggering when you consider the following: If you are paying $1,000 per month for an apartment over the next five years you will pay your landlord $60,000 and if you are renting a house, you may be paying much more than that each month. Either way, you gain no equity by paying out this monthly housing expense and you certainly won’t benefit as the property increases in value.

However, if you were to purchase your own home or condominium, you would be well on your way toward building equity within that same five-year period. By choosing a fixed-rate loan program, you will have the comfort of knowing that your monthly mortgage payment will never go up. In fact, you may have the option of refinancing to a lower interest rate at some point in the future should interest rates drop, and this would cause your monthly mortgage payment to go down.

In addition to building equity, there are tax advantages that come into play with home ownership. Depending on your tax bracket, owning a home is often less expensive than renting after taxes. Interest payments on a mortgage below $1 million are tax-deductible, and your mortgage consultant should help you evaluate the tax advantages of various loan scenarios, and share this information with your tax consultant to create the financing strategy that works best for you.

To find the loan program that is right for you, your mortgage consultant will need to evaluate your monthly household income, current assets and savings, as well as any monthly obligations you may have for credit card payments, car payments, child support, etc. These prequalification factors, along with the report of your credit score, will determine how much house you can afford and which mortgage options can be made available to you. It is also important to let your mortgage consultant know what your future goals are, because this will help narrow down which loan option is the best fit for your long-term needs.

There are many different types of loan programs available, including “low” and “no” down payment mortgage programs. These types of programs require the borrower to provide from zero to 3 percent of the purchase price as down payment. FHA lenders require that the mortgage payment, including principal, interest, taxes and insurance (PITI) should not exceed 31 percent of your gross income, and the PITI plus other long-term debt (car payments, etc.) should not exceed 43 percent of your gross income.

Regardless if you are renting or buying a home, housing expenses are a significant portion of your monthly budget. If you are renting and feel that “home” is more than just a place to hang your hat, think about the advantages of purchasing a home of your own.

Refinance Your Mortgage for Rate and Payment Reductions

The primary reason homeowners refinance their mortgage is to obtain a lower interest rate and lower monthly payments. By refinancing, the borrower pays off their existing mortgage in favor of a mortgage with a lower interest rate or longer repayment terms. This can often be accomplished with a no-points no-fees loan program, which essentially means at “no cost” to the borrower.

In the no-points no-fees scenario, the mortgage consultant uses rebate monies paid by the secondary market to pay the non-recurring closing costs for the borrower. These are one time fees such as title insurance, document preparation, tax service, flood certification, processing and underwriting, etc. The borrower is still responsible for recurring fees such as insurance and property tax escrow payments.

Refinancing typically occurs when mortgage interest rates drop significantly, but borrowers with recently improved credit scores are often candidates for better interest rates as well. If you haven’t checked your credit score in a while, it’s a good time to call a mortgage consultant to obtain your credit scores.

Another primary motivator for refinancing occurs when a borrower has an adjustable rate mortgage that is near the end of the fixed rate period. We presently are providing financing in an environment were short term rates (adjustable rates) and long term rates (fixed rates) are essentially the same, as a result of an economic phenomenon called the inverted yield curve when measuring the indexes that determine these rates. As a result, borrowers who are scheduled for a future rate adjustment will want to explore refinancing to avoid significantly higher monthly payments as rates continue to rise.

We have many clients who have chosen to refinance in order to pay their mortgage off in a shorter period of time. There are two primary methods used to accomplish this goal and we work hand-in-hand with the borrower to determine what type of mortgage best addresses the goals and objectives of the borrower and if the present mortgage is the best solution.

One approach is to structure a mortgage that allows the borrower to save the greatest amount of interest over time and pre-pay the mortgage by a significant number of years. If refinancing results in a lower monthly payment, the borrower can still continue making the monthly payment amount made on the original mortgage, and the extra money will be applied to the principal balance.

Another approach has been promoted by best-selling author and investment guru Douglas Andrew’s philosophies in the book “Missed Fortune,” which suggest investing the monthly payment savings in an interest bearing account that could earn a better rate of return and grow to the amount of the mortgage in even less time. This method provides excellent liquidity, but having more direct access to this money may be too tempting for some homeowners.

Regardless of the reason for the refinance, the mortgage consultant will need to know what the existing loan scenario entails, review the homeowner’s long-term goals, and provide a comprehensive spreadsheet that compares and contrasts the various loan programs available.

It is important to note that refinancing to obtain a lower interest payment could also result in a lower deduction at tax time. The mortgage consultant and accountant should work hand-in-hand to ensure that the homeowners’ objectives are being met.

Commentary from Real Estate Today! Radio Show 11.11.2006

The world renowned Pediatrician Dr. Benjamin Spock once said “A human being is happiest and most successful when dedicated to a cause outside his own individual, selfish satisfaction.”

A day in the life of a real estate agent or mortgage banker can be filed with triumphant mountain top moments and at times heart breaking realities – as we assist families in making their home dreams a reality and help many clients work through life’s challenges.

I want to share with you two experiences from the past week. We have been assisting a family, a wonderful husband and wife with four children in achieving the dream of purchasing their first home and providing long term security for their family. Opportunities for first time homebuyers have increased dramatically since the American Dream Down payment Initiative was signed into law in December 2003. The American Dream Down payment Assistance Act authorizes up to $200 million annually for fiscal years 2004 – 2007 to increase the homeownership rate, especially among lower income and minority households, and to revitalize and stabilize communities. Our team has become expert in working with first time homebuyers and it was a thrill to assist another family by utilizing down payment assistance – they will close on their home next week.

The second experience was less joyful. I sat down with a homeowner in the final stages of foreclosure and helped her work through the options that remain available to her in an effort to salvage the equity she and her husband have in their home. The most common mistake I see made by individuals facing foreclosure is failing to act as early in the process as possible, which limits the options available to them to resolve the problem. In Colorado the foreclosure process is statutory and there are strict guidelines that must be followed to provide the homeowner a reasonable time to restore past due payments or pay the loan in full trough a refinance -- or the sale of the property. The longer a homeowner waits to act, the more difficult it becomes to achieve a favorable outcome. This family being in the later stages of the foreclosure process will need to consider a sale as a means of solving the problem and getting a fresh start.

One of the primary objectives of the Real Estate Today Team is to educate and to advocate for homeowners, in achieving the mountain top moments and guiding them through the challenges they may face at a given time.

We have assembled a great team whose members bring a wide range of experience and a common passion to serve their clients.

Commentary from Real Estate Today! Radio Show 11.04.2006

I must admit that I had a Field of Dreams moment last week, you know “if you build it they will come.” I was having lunch with a colleague and he asks me how we are going to build the audience for our new show. I got to thinking about that question and came to the realization that I have no intention of building an audience -- well at least not in the traditional sense.

My objective is to build a community of listeners rather than a traditional audience. Think of a neighborhood, the foundation is put into place by planners and developers, individuals move into the newly created neighborhood one at a time, get to know one another, interact and engage together – forming a community. That is my objective, to put into place a foundation – our show, and invite each of you to engage with us and form a community of listeners.

Talk radio is powerful because it is interactive and a safe place to ask questions, share opinions, and contribute to the knowledge of others.

The “Real Estate Today!” team seeks to add value for you and to do so with Integrity.

As a licensed real estate broker, certified mortgage lender by the Colorado Mortgage Lenders Association and past Chairman of the Colorado Real Estate Appraisers Board, I want to bring my 20 years of unique experience and passion for real estate to our community of listeners.

We have assembled a great team whose members bring a wide range of experience and a common passion to serve their clients.

Today we are launching our new radio show.

Well after a whirlwind few weeks, we launch our new talk radio program "Real Estate Today!" on KNUS Radio 710 AM. We were able to rely on our web team Jim Dittman and Krisit Dittman, our webmaster of W3Now to pull together a new website at www.jamesholmesonline.com which will serve as the portal to our online community.

The show represents the marriage of two passions for me, first my desire to add value to the broadest number of individuals when selling, buying, or refinancing real estate. The second is a return to talk radio, which has been a significant part of my life since childhood. My mom is a huge talk radio fan and I grew up listening to the local legends of talk radio in Denver; Alan Berg, Gary Tesler, Kathy Bradshaw, and Peter Boyles among others.

This is my second bite at the apple. I hosted two motor-sports programs in the period between 1989 and 1996 - the first on KBIG and the later as co-host with the late Ted Douglass on KQXI, our show was called "The Motor Racing Review" and I learned most of what I know about radio from Ted. As our mic goes hot today, I will be thinking of Ted and my first show is dedicated to his memory.

Private Mortgage Banking



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