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Loan Rates
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Annual Percentage Rate:
Loans are generally decided on the rate of interest basis. A 5.75% loan means if your loan is $100 this year , it will become $105.75 next year and so on. In case of home loans another loan program is used and this is known as Annual percentage rate, this not only shows the basic interest rate but also shows up the effect of fees etc. charged by the companies. It is this rate which is used to compare the rates of different companies. As an example if the rate of interest is 5.75% then APR for one company may be 6.1 % and some other company may be 6.15 %. This will clearly show to the borrower that taking loan from the second company is going to be dearer even if the basic rate of interest is same. It is required by Federal Truth in Lending Law of mortgage companies to disclose APR at the time of advertising rates.
What does APR include:
The costs that are included for the calculation of APR generally are
1. Points . Point is actually 1% of the loan value. Some companies give discount points .Both these and the ones to be paid to get that %age interest are included. 2. Pre paid Interest . The emi starts from the 1st of next month but the interest is paid for the days of the month after the date of signing of the deal. Most of the companies add a 15% interest in the calculation but anything between 1 to 30 days interest can be added for the original calculations. 3. LoanProcessing fee this is charged by the bank or the financial institution 4. Underwriting fee 5. Document-preparation fee 6. Private mortgage insurance
This list also includes the following two fees sometimes:
1.loan application fee , not all banks charge this 2. credit Life insurance (This insurance is done for the loan to be paid off if the borrower
is no more. ) In general this is waived off if the down payment is 20%.
For calculations of APR the following fees are not included:
1. Appraisal fee 2. Notary fee 3. Attorney fee 4. Closing agents document preparation fee 5. Credit report fee 6. Transfer taxes 7. Recording fee 8. Appraisal fee 9. Title fee 10. Escrow fee
How does it help:
The best way of studying this is with an example.Say there are two banks offering the same period loan as follows
This means even if the rate of interest is lower in Bank B one has to pay more money in start to get the loan. Now a careful calculation will have to be done as to how much interest will be saved and what will be the overall effect. And supposing the house is left after taking another loan for another home after some years how much will be the saving in interest. This is not a hypothetical condition. In actual 90 % of the borrowers in USA buy another home or refinance their mortgage in 2 5 years.
Obviously all these are complicated and confusing calculations. To remove this confusion the concept of APR helps. At a glance the borrower can know what are the initial payments of a particular bank and where he stands in the overall payment term. In the above example the APR of A maybe 6.25 % and that of B may come to 6.72%. Now there is no confusion.
How sound is this Figure:
Though APR does give an overall idea about the condition of loan to the borrower but there are some places where this in itself is not enough and the borrower has to ask the lender company for a detailed estimate of all the costs he will have to bear from start to the end. Some of these points are highlighted below : 1. APR is confusing as it includes only a few and not every one of the lender fee or the insurance premium as is clear from the lists given above. It differs from lender to lender and from loan to loan. 2. The points payment for a 15 year loan will be averaged for 15 but if the loan is a 30 Year loan then it will be averaged for 30. Naturally the APR will be lower in case of a 30 year loan keeping every thing else as same. 3. The interest rates normally vary as per the index rate which is not constant , it is natural that the basis for all payments depending on this are also changing. This makes the APR quite confusing sometimes. 4. APR does not indicate about balloon payments or prepayment penalties or other points as to the rate of interest change. The rate may be fixed for some years and then will change. This can not be reflected in the calculation of APRs.
APR Formula:
Section 226.22(a) of Regulation Z provides the necessary basics for the calculation of APR in the US. The formula is a complicated one and in general computer calculating sites are available to give the values directly.
where: S is the balance of cash flows (almost always zero since the lender will insist on being fully repaid) • k is the current cash flow • N is the total number of cash flows • Ak is the cash flow (payment or drawdown) of the current period, and tk is the interval, expressed in years and fractions of a year between the date of the first cash flow and the date of the current cash flow. (t1 = 0.)
Conclusion:
Though all the points are not included in the formula , yet this is the best way to judge the deal for loans. Once the loan is decided then a detailed actual list of the payments is taken from the lender and on the basis of that other decisions are taken .The best use of this formula is the safeguard from fraudulent lenders for borrowers who are not that much educated and do not understand the intricacies of loan-taking.
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