Roger Schlesinger
To me an A.P.R. means Another Problem for Roger. It is the government's attempt to have the mortgage industry explain their entire operational slate in one simple manner. This is impossible and thus helps render this as useful as teaching David Letterman manners (seems like it could work, but it doesn't). I contend that if the selective memory borrowers or liars, who swore with a straight face they never understood the 1% option ARM (Adjusted Rate Mortgage) and therefore aren't responsible for the results, I can't imagine what they could do with a seven year ARM at the start of the first or second variable period. As my baseball coach used to say, "as sure as God made little green apples," we will be hearing from the same folks who had an option ARM (see above) who refinanced to a short term fixed ARM swearing someday, to anyone in Congress that would listen, that they expected the rate to go down after the fixed period because the A.P.R. was lower than the fixed rate portion of the loan. Who is to blame for that little bit of chicanery?

The answer to that question is the government. The A.P.R. idea was started for cars which are generally financed three to five years. If you could look at the Annual Percentage Rate, you quite possibly would pick the lowest interest offer instead of trying to figure it out for yourself. Hint: The government doesn't think you are very smart. As my mother would have said to that, "likewise, I'm sure." What works for automobiles, although we aren't that positive as all the American car manufacturers are bankrupt (except Ford), doesn't come close to working for the mortgage or home finance industry. We finance homes for 1 year up to 40 or 50 years and during that time, the rate can change 100 times. Put that in a formula and let the people use it!

The problem lies in many areas, but for a variable, especially a short term fixed ARM, it is truly misleading. Right now, when we have short term ARMs in the 4% and 5% range, one would think they could get a fairly good reading. Generally, short term and long term rates work on an almost flat interest rate curve, however, it is currently very steep. The one year LIBOR rate is 1.6%. Most variable rate mortgages, but not all, are tied to this index because it is international. After the fixed period, the mortgage loan becomes an adjustable which can adjust one or two times a year in most cases. There is a margin, short for profit margin, that the lender adds to the index rate for your interest rate. Most margins are in the 2% range, so if we use 2.5% and add it to the 1.6%, the new interest rate, if the loan was adjusting today, would be 4.1%. We cannot predict where this is going, we must use today's reset interest rate for the rest of the term of the loan. If you had a 5 year fixed loan and it amortized for 30 years, you would have 25 years of a variable loan left. If your initial rate was 5.1% fixed for 5 years and the adjustment rate is 4.1% as I stated above, the A.P.R. for the entire 30 year loan, setting closing costs aside for this example, is 4.26% (5 years @ 5.1% and 25 years at 4.1%). Confusion by the borrowers is expected and is definitely there to be seen by anyone with 20/400 vision or better!

The most practical use for the A.P.R. in home financing is determining how large the closing costs are, including the points being charged on a fixed rate loan. Many lenders advertise their rates and follow them with an A.P.R. but fail to tell the borrower how many points, if any, are being charged. You can tell because the spread between a fixed interest rate and an A.P.R. is usually about .1% to .125%. When points are added, the A.P.R. can get as high as .2% or more on a conforming loan.

Another problem that arises in using the A.P.R. for guidance when looking for a mortgage is that not everyone measures it the same way. I have seen brokers include property taxes when figuring the cost of the loan and I am sure that prepaid interest has shown up at times. The whole thing is an exercise in nonsense. If you are going to get a 5% rate, your payments will be figured at 5% even though the A.P.R. is 5.126%. What did you gain by knowing the A.P.R was 5.126%? Many people generally tell me their A.P.R. and can't remember their actual rate.

In the mortgage industry, whenever you apply for a loan you get a Truth in Lending Statement and a Good Faith Estimate of Costs. With the new rules in the industry, your final costs have to mirror this Good Faith Estimate of Costs, and being that is what everyone is concerned about, why must we bother with the A.P.R.? I believe it is another one of the "sacred cows " I have talked about in earlier articles that are there because no one knows who set them up, and everyone is afraid to stop sending this out for fear of the unknown. Realize the government sets these rules up. Government is the owner of Fannie Mae and Freddie Mac, never hesitate to talk about an interest rate without an A.P.R. In December of last year they said interest rates on home mortgages have to come down into the 4% range. Where was their A.P.R.? In loan modification, you have hear the President talk about 2% for those who could only make the payments work at that interest rate. What A.P.R., please? I guess what is good for us isn't important to them. What a surprise!

As we have seen in so many other examples, the government makes rules, sometimes laws, and never worries about the consequences. As an example I certainly can bring up the A.P.R. on a short term fixed variable loan as I did above. Do you think those who we know will be screaming when their adjustment turns out to be higher than the fixed rate, when the A.P.R. was lower, have anything to gripe about? I am not a big fan of gripers or griping itself, but this time they just may have a point.

Roger Schlesinger

Roger Schlesinger's Mortgage Minute is heard on hundreds of radio stations and daily on the Hugh Hewitt radio show and Michael Medved shows. Roger interacts with his hosts and explores the complicated financial markets in order to enlighten his listeners and direct them along their own unique road to financial freedom.