APR: What is it? Does it affect your mortgage loan?

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Before we look at how an APR is actually computed, remember that there are two different ways that the fees you pay when buying a house and getting a mortgage are determined. Some are a percentage of the loan. Some aren’t. Appraisal fees, for example, will be the same regardless of the size of the loan. In this case the size and value of the home plus the amount of time and work that an appraiser spends determine the cost of the appraisal.

Other charges, such as the broker’s fee, are usually a percentage of the loan. The APR normally includes the broker’s charge, any loan origination charges, processing and underwriting fees, and discount points, which are a form of prepaid interest. Private mortgage insurance (Private MI) is also included. Private MI is required when a single loan exceeds more than 80 percent of the cost of the house. It protects the lender against loss if the homeowner becomes delinquent with mortgage payments. So if you get an $85,000 mortgage on a $100,000 house you will pay private mortgage insurance. With an $80,000 loan on the same house, you won’t. Mortgage insurance can add hundreds of dollars a year to your monthly payments—maybe even thousands. Government-backed loans, such as Federal Housing Administration (FHA) or Department of Veterans Affairs (VA) loans, include FHA insurance or VA funding fees, which are similar to Private MI.

In some cases additional non-standard charges can be added. When in doubt, ask your lender—or potential lender. They are required to give you this information. The charges will be listed on the Good Faith Estimate that a lender is required by law to give you within three days after applying for the mortgage and before you commit to taking the loan. Pay special attention to those items listed in the 800 and 1300 sections of the estimate because these listings can contain numbers that vary from lender to lender, while sections 900 through 1200 are fairly standard. Be especially aware of miscellaneous charges that could add significantly to your APR. You might need help determining exactly what counts toward the APR and what doesn’t. Don’t hesitate to ask your lender about any charges that are unclear or differ greatly from those charged by another lender.

What all these factors have in common is that they are tied directly to the loan, not to the home. On the other hand, charges tied to the home and not the loan are not in the APR equation. These include charges related to items such as a title search and title insurance, as well as property insurance, money for taxes, legal and notary fees and so forth. You would still have to pay for all of these things even if you paid cash for the house.

Now let’s look at how the APR is determined. Let’s say you need to borrow $100,000 at 5.5 percent to buy your home, but when you look at the loan documents you see that you are actually paying $102,500 to get the loan for $100,000. While $100,000 goes to the seller, the additional $2,500 is added to cover fees associated with getting the loan. Your gross loan amount is for $100,000, but you really only received $97,500 net because you had to pay $2,500 in fees. The difference between the gross loan amount and your net loan amount will determine how much the APR is over the initial rate on the home loan. In this case you are actually paying 5.75 percent (the APR) to pay off the $100,000 you borrowed for the house. Calculating the APR is best left to the lender, who has software to perform this function. He or she must furnish you with the information before the loan is finalized.

What does this mean to you when you go shopping for a loan? It means that you have the ammunition to determine which lender is making the offer that will best meet your needs. Taking out a mortgage loan is a big financial decision, so it is wise to be sure that you are making the right one.