APR was created by our government to help consumers select a mortgage rate. It was intended to be a tool that would allow someone to simply compare various mortgage scenarios and shop mortgage lenders for the “best rate” at the lowest cost. Unfortunately, APR is probably not providing an accurate view of what the true cost of the mortgage, whether it’s for a home purchase or refinance, is.
It’s widely known that APR is easily manipulated. You could probably ask ten different mortgage originators to provide you quotes at the same rate and same cost, and receive ten different APRs. Sometimes it may be an accident, a mortgage originator forgets to factor in an escrow fee or private mortgage insurance premiums, and sometimes it’s not. For example, I’ve seen plenty of misleading ads on the internet (and other media) where APRs are an obvious bait and switch tactic for mortgage lead generating companies.
It recently came to my attention that some loan operating systems (LOS), tools that mortgage originators use to originate and process loan applications, have built in defaults that prevent APR from being correctly quoted. Much to my dismay, I’m told that the LOS our company uses does not factor rate rebate credit towards the closing cost when calculating the APR. This means that if I price out a refinance with a rate that has enough rebate credit to pay all closing cost, the APR that I am disclosing would be the same as a refinance without any rate rebate. It’s erring on the side of side of the consumer, however, it’s not accurate and if you’re relying on APR and looking for a mortgage rate quote for your home in Washington with rebate pricing, you might not select my quote even if my net cost are lower. The LOS our company uses is one of the leading LOS in the nation, so it’s not just my APRs that are impacted.
In addition, our company factors in the appraisal fee into the APR when most do not.
I’ve always cautioned my clients against using APR as a tool to shop mortgage rates. Despite our government’s good intentions, the system is flawed.
What can you do?
In my opinion, the only way you can truly select a mortgage program when considering the cost of a mortgage rate is to compare the rate to the net cost. When I’m pricing a mortgage rate, it either has discount points, which buys the rate lower OR it has rebate credit reducing closing cost, which is caused by having a slightly higher mortgage rate.
For example, this morning (10/3/12 8:15am) I’m quoting a rate term refinance with a loan amount of $190,000 for home owners with excellent credit and a loan to value under 60% in West Seattle. Closing cost (includes title, escrow, appraisal and lender fees – not including prepaids or reserves) are estimated at $2880.
2.500% with an apr of 2.768% has a discount (cost) of $1115. The net cost of this rate is the discount plus the closing cost = $3995 ($1115 plus $2880). Principal and interest (P&I) payment is $1,266.90, dropping their mortgage payment by $260 per month!
2.750% with a disclosed apr of 2.936% has a rebate credit of $925 reducing the closing cost for this rate to $1955 ($2880 less $925). P&I=$1289.38, reducing their mortgage payment by $238 each month. NOTE: remember, Encompass360 is not calculating the rebate credit into the apr, causing this apr to appear higher than what it actually should be. I’m hoping Encompass (Ellie Mae) will resolve this issue!
Here are a few tips for comparing rates:
- Do not factor the prepaids or reserves when shopping rates. Do check to see if the mortgage originator is properly disclosing them. However, they are not an actual “closing cost”. The mortgage originator does not have control over how much your property taxes or home owners insurance is. If you’re doing a refinance and have an existing reserve account, it is typically refunded to you by the mortgage servicer a few weeks after closing.
- Compare the net closing cost with the interest rate. Your net closing cost will be discount points plus closing cost OR it will be closing cost minus the rebate credit.
- If you’re shopping other mortgage lenders, make sure you try to get the quotes at the same time. Mortgage rates change constantly – sometimes several times a day. Shopping one lender on Monday morning, another on the afternoon and one on Tuesday, is not comparing rates “apples to apples”. Mortgage rates are based on mortgage backed securities (bonds) and pricing moves similar to the stock market.
- Compare by the same lock period or a lock period that is appropriate for your scenario. For example, if you’re comparing a refinance where you’re paying off your second mortgage and one where you’re going to subordinate the second mortgage – subordinations tend to require a much longer time period.
- Make sure that you provide enough information for the mortgage originator to provide an accurate quote.
Of course, until you’ve locked in an interest rate, it’s subject to (and will) change or at least the pricing (rebate credit or discount cost) will change. Sometimes the change is very slight and other times, not so slight.
As Jillayne Schlicke, a real estate educator in the greater Seattle area, says: APR is just one part of the mortgage machine. If you want to get an accurate view of your quote of the cost of your refinance or home purchase quote, you’re going to have to do some quick math.
If you would like me to provide you with a detailed written mortgage rate quote for your purchase or refinance on a home located anywhere in Washington state (where I’m licensed), click here.