In my never-ending quest to educate the public about the mortgage industry, I have set down some subjects that are definitely either unknown or misunderstood by the average borrower. This is the third report on items I consider important if you are either holding a mortgage or about to take out your first mortgage. Here is what I am going to cover:
1. APR: Annual Percentage Rate, which was set up originally for autos and doesn't do the job it was intended to do for housing.
2. Which day is the wrong day to close an escrow and why? When is the best time to close a loan and why?
3. Names mean nothing in the mortgage industry.
4. How, when and why to lock a loan.
5. The difference between a mortgage broker and a mortgage banker.
Some of the above might seem trivial, but failure to understand can be hazardous to your wealth. Let's see what I am talking about.
Annual Percentage Rate was easy when it came to cars, not so in the mortgage business. Cars are financed over 3, 5 or 7 years for the most part and that is that. They are straight-line loans that have the same payment every month until paid off. Not so in the mortgage industry. In the auto industry, APR will give you a good idea of the annual cost of your loan. Not so in the mortgage industry. Why?
The annual percentage rate is measured by subtracting the closing costs, including points, from the loan and then dividing the actual interest payment by the new balance of the loan. The Government doesn't feel that closing costs are part of the loan, so when you take them out, the APR has to be higher. (Not always)
Example:
$200,000 loan at 6% has $12,000 in interest
Closing costs of $2,000 means the loan is $198,000
Dividing $12,000 (interest) by $198,000, you get 6.06% as the APR
The larger the difference between the interest rate and the APR, the larger the closing costs, which means you are probably paying points, as they are the variable in the equation.
The problem comes with variable loans. You can't predict where the variable will be for the life of the loan, so you use the fully indexed rate at the time of closing: the margin plus the index. You then subtract the closing costs and do as above. This is a fictitious number because it is a variable. It is even worse when you have a fixed portion for a period of time and then it becomes a variable.
Example:
Five-year arm at 6% (fixed for 5 years and then becomes a variable)
With a fully indexed rate of 5% (margin and index at time of closing)
Because you blend five years at six percent and 25 years at five percent, your APR will be less than your start rate (more silliness).
Continued... |