I told you in my last post, I was going to do it. Did you not believe me?
Important Disclosure: Skip to the bottom if you’re in a hurry.
Picture this: Every conversation with your friends includes one of them telling you how low their mortgage rate is. You research mortgage refinancing rules-of-thumb and decide you too can benefit from these historic lows. Finally getting the courage up to approach your lender, you spend weeks gathering necessary paystubs and tax returns. Appraisals have been completed and the county confirms there are no outstanding liens on your property (did they not believe you?).
It’s now a few weeks after you’ve originally submitted your application and you’re wondering whether this headache-of-a-process is ultimately worth it; when you get that phone call “Mr. Smith, your loan is ready to close.”
You can now taste that 4.0% interest rate and boy, does it smell good. We’ll say it tastes like chicken (assuming chicken can significantly reduce your monthly expenditures).
The attorney, whom you’ve only spoken with over the phone, finally shakes your hand and asks if you’d like some water. He pulls out a stack of papers, all with your first, middle, and last name smeared all over them. It’s time to sign.
You take a deep breath, a sigh of relief. What seemed “too good to be true” has now become legally binding.
Okay, first page. Security note looks good.
Second page, Truth In Lending (TIL). Almost as important a disclosure as the warning I gave you before reading this lengthy post.
Wait a second.
This can’t be real. What happened to my 4.0% interest rate? You’re telling me it’s 4.0% but this paper clearly says 4.5%. What is going on here? http://www.youtube.com/watch?v=FMHdlka9fvA
Before you get your panties in a wad, you can breathe easy knowing your 4.0% is still intact. What you’re reading is the Annual Percentage Rate (APR).
What is the difference between interest rate and APR?
I like things that are easy to remember. Definitions are difficult to recite; therefore, we will withdraw from Webster’s and Wiki (what?).
When you borrow money (mortgage, auto loan, etc.) you will pay interest. If your loan is 30 years (traditional mortgage) the interest rate will tell you how much interest you’ll pay over those 30 years.
99% (made up statistic) of all loans have closing costs associated with them. They can be disguised as Origination fees or Processing Fees, among many others. It could also include whatever compensation the loan originator receives for originating your loan.
The APR simply includes whatever fees are associated with the loan and adds it to the interest you’re paying. The APR will assume you are keeping the loan for the entire loan term, in this case 30 years.
Interest Rate = Interest
Annual Percentage Rate = Interest + Costs
That should be relatively easy to remember. In upcoming posts I will explore when it is truly beneficial to refinance; but, I hope this was a helpful heads-up.