What is APR

carmen_grower_2007March 24, 2009

I have been quoted a flat rate on a refinance of 5% (5.9% APR). What does that mean? I am trying to do a comparison and find one bank is giving a rate 6.25% with closing costs of $1200 and another at 5% with closing costs of $2900.

This is only a $50,000 mortgage and I don't know what I should be asking. Any help will be appreciated!

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pamghatten

That's a good question ... APR is supposed to be a way that you can compare lenders, based on rate and closing costs. It assumes that you are comparing apples to apples ... a 5% and closing costs at one lender, to a 5% and closing costs to another lender ... the APR's would reflect the closing costs that each charges.

You could also compare the 2 you are looking at, though it seems your spread is pretty wide between the 2 interest rates.

Personally, I would want the lower rate, and then try to get the lowest closing costs possible ... mot of the closing costs can be financed into your refinance, or you can pay them out of pocket.

Hope that helps.

    Bookmark   March 24, 2009 at 10:55AM
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dave_donhoff

Hi Carmen,

I could go into detail to explain APR (as I know that is the face question,) however what you are really seeking is a way to simplify the complexity in comparing financial options.

APR was initially designed to attempt to do exactly that; simplify the myriad complexities of financing into a single comparable/shoppable number. Unfortunately, it fails (quite miserably.) APR *could* theoretically be a shoppable number if;
A) everyone calculated it the same way (they don't,)
B) all shoppers knew how to only compare APRs of like loans (they don't,)
C) the future effects of the programs compared didn't matter (unfortunately, they do...and APR is blind to the future financial effects of the loans compared.)

SO... even though all financial providers are required by law to quote an 'APR' you are wisely advised to completely ignore it (especially because of #A, above.)

INSTEAD;
1) Determine your most likely length of time desired for your loan life (until you pay off due to sale, or cash accumulation, or rebalancing of your balance sheet/portfolio.)
2) Minimize your forced amortization (i.e. get the longest loan period offered,) unless you are self-aware of a budgeting problem, and managing your own reserves is a bad idea.
3) determine breakeven periods (monthly cash savings divided into closing costs) for each potential loan structure, and make sure your breakeven is well short of your projected financing timespan.

Lastly... my ancient rant;
Choose your provider according to preliminary "quotes,"
And you've simply chosen the most successful 'Liar.'*

*The 'REAL' best loan rates are only knowable after its
too late to change providers... so the Quoters (who know
better) are taught to simply say whatever they think you
want to hear.

INSTEAD... Choose according to character quality,
competitiveness, honesty, and your personal assessment,
And you will set yourself up for the better Experience AND
the better ultimate financial results!©

Cheers,
Dave Donhoff
Leverage Planner

    Bookmark   March 24, 2009 at 1:47PM
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carmen_grower_2007

Thanks so much Dave. The highest quote on interest rate and the lowest on costs was my personal local bank. They specifically said they would keep the loan and not sell it because I didn't meet the specs for Freddie Mac (My house can't sit on more than 5 acres- it does.)

The other two weren't interested in anything much except that I am a good credit risk (805 score) and seemed like I believed all the double talk. As I look at the amounts they both gave as 'closing costs', it didn't jive with my computer - one is telling me that my closing costs are under $3,000 but I want a $50,000 mortgage and they are giving me a $57,500 mortgage with all costs financed. Hmmmm.

My current rate is 7.625% and I am thinking I will just not refinance since I don't want to be taken. I could easily add $200 to each payment - would that make sense?

    Bookmark   March 24, 2009 at 3:30PM
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dave_donhoff

Hi Carmen,
Yes... skip the refi... and further; ACCUMULATE your additional $200 a month (rather than paying it to the bank.)

After you accumulate an amount sufficient to pay the remaining balance in one check, THEN consider paying it off.

The value of preserving your cash, at present, is far safer & more conservative than the incremental interest savings you'd get at $200 a month from principal.

Remember; EVERYONE should eliminate their mortgage... but ONLY when they can SAFELY afford to do so (and not a day nor a dollar earlier!) 'Creeping' across a landmine field (i.e. prepaying additional bits & pieces of your mortgage principal) is better to be avoided if possible.

Cheers,
Dave Donhoff
Leverage Planner

    Bookmark   March 24, 2009 at 4:03PM
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carmen_grower_2007

OK. Now, if I pay an extra $200 on my mortgage which I am paying 7.625% interest each month, how can this be bad? I am just asking here. It seems like I am getting 7.625% on money that I would be lucky to get 4% on in any other investment.

What am I missing?

    Bookmark   March 24, 2009 at 5:20PM
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dave_donhoff

Hi Carmen,

OK. Now, if I pay an extra $200 on my mortgage which I am paying 7.625% interest each month, how can this be bad?

It can be bad if you find yourself in need of the cash you've irretrievably surrendered, and re-accessing it in the times of urgency/emergency costs you significantly more than the incremental savings you'd acquired.

Of course, there's no way of knowing for sure if you'll find yourself in this position (that's why they call it "surprise" ;~) Prudent caution would be to prepare for the worst, in any case.

Generally speaking, if you already have sufficient liquid cash reserves to cover at least 12 months of your total living costs, and your working capital is sufficient to retire on its safe yield, THEN you could certainly surrender additional unneeded cash to retire your mortgage leverage fairly safely.

I am just asking here. It seems like I am getting 7.625% on money that I would be lucky to get 4% on in any other investment. What am I missing?

The apparent 3.65% difference, annually, on a monthly $200 balance, in real dollar terms, could be "NOTHING" compared to the costs of emergency cash access if you're not properly prepared.

Again, maybe you already are sufficiently prepared... but most people thinking about "slivering away" their mortgage bit-by-bit are not anywhere near sufficiently prepared in safety reserves & secure income to do so.

Cheers,
Dave Donhoff
Leverage Planner

    Bookmark   March 24, 2009 at 5:44PM
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