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APR, what is it and why it doesn’t matter

You see APR after every interest rate quoted, whether it’s for an auto loan, credit card or a mortgage loan.  What does mean?  How is it calculated?  Does it really matter in the larger scheme of things?  All good questions.

APR means “Annual Percentage Rate”, which is a number that is supposed to somehow tell you the “true” cost of a loan.  The idea is that this number reflects the actual cost of a loan based on any fees required to originate and fund it.  With credit cards the interest rate and the APR are almost always the same because they just give you the credit card and there are not  closing costs involved.  Same with most auto loans.  But with mortgages the quoted interest rate and the APR are almost always different.  Here’s why.

APR is figured by subtracting the fees associated with originating a loan from the loan amount than re-amortizing the payments you’ll make to come-up with “true” cost of the loan.  So if your loan is $200,000 and there are $7,000 worth of fees associated with the loan, the APR would be the dollar amount of actual payments over the term of the loan recalculated into $193,000 rather than $200,000, hence the sum is a higher percentage.

Originally, our government came-up with this figure in an attempt to simplify the home loan shopping process since a borrower could go around to various lending institutions armed with this one figure to see who had the best deal.  However, it doesn’t really work that way because there are way to many variables, both in loan products and in what is considered an “APR item”.

First lets look at what are considered APR items.  HUD says that any fee associated with originating a loan that would not be associated with a cash transaction is an APR item.  However even that is left to the lender’s discretion.  For instance, on the Good Faith Estimate anything in the 800-series section should be considered an APR item as well as Per Diem interest (the interest that has to be prepaid from the closing date of your loan to the first day of the next month) and of course things like up-front fees for mortgage insurance or funding fees through the VA and escrow fees from a title company or attorney.800-section-gfe1

Some of these items are self-explanatory, such as “Loan Origination Fee”, “Credit Report”, “Mortgage Broker Fee” and “Underwriting Fee” because you wouldn’t have those fees if cash were exchanging hands.  However some other such as appraisal and title escrow fees could or could not be included, and lenders use this to their advantage when quoting you so that their fees/APR will look more competitive.  They will leave-out appraisal and title fees since in a cash transaction you may not get an appraisal done or have a title company handle the money transaction or issue a title insurance policy.  But lets face it, it would be financial suicide to buy a home without knowing how much it’s really worth and having a third party handle the transfer of funds from buyer to seller is the safest way to go since they won’t release the funds to the Seller until the title is recorded with the County Clerks office the the Buyer is the legitimate owner of the property in it’s entirety.   Also, title insurance guarantees the buyer that the title is clean and free of encumbrances (liens from collection agencies, bail bonds, contractors, angry neighbors, etc.) and guarantees that if one shows-up for the Seller after the transaction that it won’t effect the Buyer.

So the smart move, even in a cash transaction, is to get an appraisal and use a title company or attorney to complete the transaction and get title insurance.  So legitimately these fees should be included, but many lenders don’t to be more competitive in their quotes.

Second, APR is calculated assuming the loan will be held to term (10, 20, or 30 years) and never refinanced or the house sold.  The fact is that people move on the average of every 7 years and refinance every 4, racially skewing the APR calculation and making it worthless in the real world.

So in my opinion, the only figures that matter in a purchase or refinance transaction are:

  1. What’s the interest rate?
  2. What’s the monthly payment? (Remember, the lowest interest rate doesn’t always equal the lowest payment)
  3. What are the closing costs involved?
  4. How long will it take to amortize and recoup the closings costs? ( In a refinance scenario)
  5. Who is paying the closing costs? (In a purchase scenario)

This is where a mortgage professional can sit down with you in person and answer these questions for you and show you the mortgage options available to you.

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2009 First-Time Home Buyer Tax Credit Fact Sheet

Who is Eligible

  • The $8,000 tax credit is available for first-time home buyers only.
  • The law defines “first-time home buyer” as a buyer who has not owned a principal residence during the three-year period prior to the purchase.
  • All U.S. citizens who file taxes are eligible to participate in the program.

Payback Provisions

  • The tax credit is a true credit. It does not have to be repaid.
  • The only repayment requirement is if the home owner sold the home within three years after the purchase.
    Income Limits
  • Home buyers who file as single or head-of-household taxpayers can claim the full $8,000 credit if their modified adjusted gross income (MAGI) is less than $75,000.
  • For married couples filing a joint return, the income limit doubles to $150,000.
  • Single or head-of-household taxpayers who earn between $75,000 and $95,000 are eligible to receive a partial first-time home buyer tax credit.
  • Married couples who earn between $150,000 and $170,000 are eligible to receive a partial first-time home buyer tax credit.
  • The credit is not available for single taxpayers whose MAGI is greater than $95,000 and married couples with a MAGI that exceeds $170,000.

Effective Dates for the Tax Credit

  • First-time home buyers would receive an $8,000 tax credit for the purchase of any home on or after January 1, 2009 and before December 1, 2009. To qualify, you must actually close on the sale of the home during this period.
    Tax Credit is Refundable
  • A refundable credit means that if you pay less than $8,000 in federal income taxes, then the government will write you a check for the difference.
  • For example, if you owe $5,000 in federal income taxes, you would pay nothing to the IRS and receive a $3,000 payment from the government.
  • If you are due to receive a $1,000 tax refund from the government, your refund would grow to $9,000 ($1,000 plus $8,000 from the home buyer tax credit).
  • Buyers can take the tax credit on their 2008 or 2009 income tax return.

Types of Homes that Qualify for the Tax Credit

  • All homes, whether single-family, townhomes or condominium apartments will qualify, provided that the home will be used as a principal residence and the buyer has not owned a principal residence in the prior three years. This also includes newly-constructed homes.

For more details on the tax credit, go to www.federalhousingtaxcredit.com

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Salt Lake City Mortgage Market Update for January 13, 2009

Stocks are trading a bit higher today, particularly the NASDAQ which historically has been a good indicator of what mortgage rates will do: when the NASDAQ is down rates are down; when the NASDAQ is up, rates are up.  This is because of the inverse actions of Stocks and Bonds.  When Stocks look bad investors move their money to lower yield, yet safer Bonds thus adding strength to them and lowering interest rates also on Mortgage Bonds.  When  Stocks look good investors transfer their money from safer, lower return Bonds to riskier but higher earning Stocks.

So far this morning the +0.49% uptick in the NASDAQ hasn’t had any real effect on Mortage Interest Rates though with rates at the same point they were at closing yesterday.

The Senate votes on the Stimulus Plan today and we’ll see what effect that has on the Stock Market.  One modification from Obama’s plan that I’m not happy about is changing the original plan’s tax credit for homebuyers from $15,000 for all home buyers this year  that does not have to be paid back to an $8,000 tax credit for first-time home buyers that only has to be repaid if the home is resold within 36-months of purchase.  This isn’t much different than the current $7,500 tax credit, and as many real estate industry advisors have stated isn’t helping much anyway because many first-time home buyers don’t have the initial downpayment to buy a home in the first place to take advantage of the tax credit 10 months from now.

If the government really wants to do something to stimulate home sales they need a credit that can be used at the closing table for down payment purposes or to pay closing costs, and they need to make it available to all home buyers for the next 12 months, or so.

But what do Realtors and loan officers know?  We’re just the one’s in the trenches dealing with home buyers everyday, so we must be way more out of touch with the market than some congressman that has never represented a home buyer in a purchase transaction.

With mortgage bonds facing resistance and stocks on the cusp of a rally today the market favors locking if you have a loan closing soon that isn’t locked yet.

For Salt Lake City, UT today’s average mortgage rates are as follows:

30-year fixed: 5.125%

15-year fixed: 4.625%

Conforming Jumbo 30-year fixed: 5.625%

FHA 30-year fixed: 5.50%

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