The government has just come out with a new form designed to explain how much a mortgage really costs. It took two years of study, revision and editing to perfect the Consumer Financial Protection Bureau’s new “loan estimate” form, paperwork designed to help consumers make better mortgage choices and hopefully avoid higher loan costs and needless foreclosures.
It took just a few days before flaws in the new form became obvious. In particular, the National Consumer Law Center wants to know why it takes until page three of a three-page form before mortgage borrowers can find the “annual percentage rate” or APR, a number which is supposed to make interest-rate comparisons easy.
The APR is not the interest rate. That would be too simple. Instead the APR represents the interest expense and certain loan costs for the mortgage over the loan term, say 30 years. Unless, of course, the loan is a reverse mortgage or a home equity line of credit, each of which defines the APR differently.
One cost of mortgage financing is usually expressed as a combination of an interest rate plus points which together represent something that is not the APR. Borrowers then have the opportunity to choose the rate-and-points combination which best meets their needs.
“The APR,” says the Federal Trade Commission, “takes into account not only the interest rate but also points, broker fees, and certain other credit charges that you may be required to pay, expressed as a yearly rate.”
This sounds simple, but imagine if Smith borrows $200,000 at 4.3 percent and pays $5,000 in loan fees and charges. He has a fixed-rate conventional mortgage with a 30-year term so the official APR is 4.515 percent.
The 4.515 percent APR is on target only if Smith holds onto his loan for 30 years. Suppose he pays off the loan, sells the house or refinances after eight years? Then the numbers change and the percentage cost for points and fees get much higher. The numbers can also change if Smith is looking at adjustable-rate mortgages.
Enough! The problem is that borrowers cannot get a straight answer to a very simple question: What’s the cost for a mortgage?
Can this problem be solved? After all, we’re the nation that sent a man to the moon and follow the Kardashians, surely we can figure out the cost of mortgage financing.
So here, as a public service, is a brief guide for the perplexed.
First, ask your lender to provide the “par” pricing for each loan. This is the interest rate with zero points. It makes it easy to compare fixed-rate financing. What about adjustable-rate mortgages? Ask about start rates and also about annual and lifetime caps but be aware, rates and costs can both rise and fall in the future.
Second, if you’re refinancing consider a loan where the lender pays all closing costs except prepaid items such as escrow money for taxes and insurance. Then compare your new monthly payment with the old one.
(If you’re refinancing with a new lender you may get a check from your current lender for any unused escrow money. If you refinance with the same lender it may be possible to just transfer escrow funds from one account to another. Also, always ask for a list of specific items which are not included among “all” closing costs. This list can differ among lenders.)
Third, if refinancing compare the cash cost of refinancing with monthly savings. Example: If it costs $3,000 to refinance and you save $150 per month the expense of refinancing will be justified if you continue the loan for more than 20 months.
Fourth, shop around before your pick a loan. It’s always good advice to let lenders fight for your business.