In the simplest terms the APR exists because you borrow money. It is calculated with the fees (referred to as Finance Charges) incurred that would otherwise not be there if you were paying cash.
You simply take the finance charges and the loan amount and add them together. You keep the monthly principal and interest payment (P&I) the same and the term (# of years i.e. 15, 20 or 30 yrs) the same and calculate what the interest rate would have to be (technically is adjusted to) in order to pay the loan off, again using the same principal and interest payment and same term.
Remember, since fees are added, finance charges, the interest rate would have to be higher in order to pay the loan off in the same amount of time with the scheduled P&I.
In the days before computers you would take the sum of the loan amount add finance charges and divide that figure into the loan amount, end up with a factor that would be looked up in a huge factor book to give you your APR.
Examples of Finance Charges:
1. Interest – the total interest paid over the life of the loan (your P&I payment multiplied by the term of your loan in months minus the principal loan amount. 30 years = 360 months etc) along with the per diem interest. Per diem interest is the day you sign you mortgage or deed of trust until the end of the month. Note: the distinction between a mortgage and deed of trust is trustees.
2. Discount points, which are nothing more than prepaid interest. Points are paid to lower an interest rate.
3. Origination fee, which technically is to be the costs to do the mortgage; examples = credit reports and appraisal. Even though lenders charge separately for those items they should not. If you want to make an issue of this fee contact your local banking commissioner. It is to be noted that if the lender has to use an outside source for processing then a processing fee may also be charged and considered part of the finance charge.
4. Costs of required services; example use of Fed-ex, UPS etc. In addition, a location survey, underwriting fee are also considered finance charges. Again, items you pay for because you are getting a loan and not paying cash.
Note: Whether you get a loan or pay cash you have to be transfer tax and stamps. Also for the recording of the Deed/Title.
Fees from the Title Company/Attorney are not included in finance charges as they are not the ones lending money.
Should you find out that the APR was disclosed improperly and it is lower on the truth in lending statement – know that you can take a lender to court and they have to adjust your payments to make the APR accurate. In other words they have to make their error your truth. The lender is only allowed a 0.125% error. Even if they just transposed numbers. If it is higher they have to correct the APR and you should have to re-sign it. If it is lower do not re-sign and take the time and effort to take advantage of their error.
Along with that little piece of advice if your final closing statement, aka settlement statement, HUD 1, is very different than your original Good Faith Estimate call your state’s banking commissioner. You should know you could be entitled to returned monies! Do not sign a 2nd good faith or truth in lending statement if it is to correct their error.
Little thing to know If you applied for an adjustable mortgage and your initial truth in lending does not show an example of worse case scenario payments for each adjustment then after the loan has closed call the banking commissioner and have the lender “make his mistake” true! You may end up with lower P&I payments for a fixed term!
Lenders are slick and for you to take advantage of their mistakes just call the banking commissioner, a congressional representative or senator! Just make sure you have your good faith estimate and initial truth in lending statement in hand along with your final HUD 1 and final truth in lending statement. The law requires intial good faith and truth in lending statement documents be delivered to a potential borrower within 3 days of application.