I read a recent well intentioned blog advising that you should not select a lender or loan based on the rate! That's great advice! Rate in itself is only one side of a coin! The other side of the coin is cost! Origination and discount cost!

Loan costs come in two forms the origination fees that are determined by the Loan Originator based on market and the anticipated work involve. Origination cost have nothing to do with the rate you receive.

The other cost are loan discount cost, which is a misnomer in that the discount can be a charge or a credit, depending on the rate you select. At higher rates mortgage brokers are paid by lender reducing what you the consumer would other wise have to pay as cash out of your pocket at closing. When a mortgage broker receives such payments (really credits to your benefit) they are called YSP* (Yield Spread Premium), when a banker charges the same rate it's called anticipated profits and is not disclosed.

*Brokers disclose YSP under line 1302 on the Good Faith Estimate and HUD-1 (closing statements) on a line labeled: "Compensation To Broker (Not Paid Out Of Loan Proceeds)" Bankers gross income is not required to be disclosed. This useless information, only causes confusion.

Our well intentioned blogger went on to advice the reader to use "APR," Annual Percentage Rate, to compare loans and lenders! There are only three excuses for such bad advice: One, "APR" was intended to be used to compare loans. Two, our government mandates all lenders to issue a "Good Faith Estimate" and "Truth in Lending" forms, including "APR" either at the time of application or with in three days there of. Three, there are those sinister loan sources that wish to legally deceive! Some suggest a fourth reason: pure stupidity! I don't believe stupid is an acceptable excuse for anything and I group the stupid with the sinister.

The "Truth in Lending" law the so called "Regulation Z" was a truly inspired bit of legislation, but Congress let HUD write the regulations. HUD issued one flawed set of regulation for all lenders and all types of loans. What worked well when the most common loan was a three year car loan never worked for a mortgage loan! Today with our much more expensive cars and relatively long term loans on them it no longer works for car loans either.

"APR" is a lie! A Government Fiat, that causes more harm than good.

Numerically I could prove that "APR" is in fact correct, but that just proves the old adage that "figures don't lie, but liar's figure!"

I have never meet anyone who's experienced any thing even close to the "APR" rate! You won't meet anyone either! In order to experience the promised "APR" rate a mortgage would have to be fully amortized with no late payments, and no pre-payment!

Today the normal mortgage is paid off in three to five years, not fifteen to thirty years. To make matters worse "APR" by it's flawed nature drastically favorers higher cost, lower interest rate loans. Borrowers who paid off early normally find out those to be very expensive loans.

Then there is the "Mortgage Insurance" distortion. "Mortgage Insurance" referred to as either MI or PMI, all are properly "MI," is part of the "APR" calculation. It distorts the "APR" because the insurance premium is included for about ten years for conventional loans (non-government loans) and for the life of FHA loans.

Including ten to thirty years MI when most loans are paid off in three to five years distorts any comparison! It's a distortion how is the consumer to know which is the better loan? This distortion is worst with FHA loans where they show at least 240 more MI payments than the conventional loans which themselves show at least sixty more MI payments than the consumer is likely to make. (I'm not advocating FHA loans, but in today's market they have to be considered.) How can you compare loans if one included 240 or more extra charges you're not likely to experience?

So far we've been referring to fixed rate loans, HUD mandates the least likely of three possible scenarios for adjustable rate mortgages, ARMs. The most likely and worst happening is that ARM index will go up. The best possible change if you have an ARM is that index goes down, is even this is more likely than the mandated calculation assuming index stays the same!

I have a solution! To compare loans fairly. To determine the best loan for the consumer! To apply common sense to loan selection! To beat the system and learn the truth.

1. Take the "Good Faiths" to become compared and locate the "Total Closing Cost" near the bottom right.

2. Add the payment (Principal and Interest, PI) to the monthly MI payment (all located bottom right on the "Good Faith")

3. Multiply the monthly payment (PI+MI) by the number of months you're likely to have that loan (36 to 60).

4. Add the total from # 3 to the closing cost from # 1.

5. Repeat this for all loans to be compared. This is the cost of the loan, over the likely life of the loan! The cost you're most likely to experience!

"APR" works only if you are going to live your Grandparents life! Only if you are going to keep the loan forever!

Bill

William J Archambault Jr

The Real Estate Investment Institute

I read the musings of a brilliant, but young mortgage man that was having trouble explaining pre-paid interest, which is line 901 on the Good Faith Estimate and HUD-1, closing statement. I discuss this in my book "Get The Money / A Consumers Guide To A Successful Mortgage Application" but let me try a different approach here.

If you ask the consumer if mortgage interest is paid in advance or in the arrears (after you've used the money) the majority would say in advance and point to the pre-paid interest charge on the Good Faith Estimate or HUD-1. If you asked the same question of a group of traditional bankers they'd be split about equally! The truth is that all mortgage interest is paid in the arrears!

Before, I address this lets look at a little history. When our parents and/or grandparents bought a house the first mortgage payment was due on the same day of the next month. This was convenient for the banks because over time they had a near equal number of payments due each day of the month. This made it easy for the bank, 50 full time bookkeepers in the basement could keep track of all the loans, had all of the loans been due on the first of the month then they would have needed 200 or more people, but for only the first week of each month.

Then came computers, suddenly there was a better way! In the late sixties banks started making all loans due on the first of the month. It was wonderful! Suddenly bankers knew exactly what each department and each account was doing everyday, even thought it was 3 days behind. This was much better than the old system where the bookkeepers reports told them where they were on one day last month.

The bank soon discovered a new problem, it took several weeks to get a new loan into the system! To allow the remaining bookkeepers and their new assistants, the keypunch operators time to get the new loans into the system the first payments were now made due on the first of the second month fallowing the loan closing.

Change is normally for the good and this one was, but change often brings new problems. The new problem was with loans due on the first of each month, loans closing and more importantly funding (interest accrues from the date of funding a loan) on everyday of the month, was that often there was not sufficient money to pay the accrued (earned) interest when the payment was made.

Lets look at the numbers. I'm going to use a $100,000.00 loan at 6.500% for 30 years, with a principal and interest payment of $632.07. The daily interest cost on the full $100,000.00 is $17.81.

If we divided the $632.07 by the daily cost of $17.81 we discover that it only pays for 35.5 days interest! So if the closing/funding is more that 35 days before the first payment the loan will not start amortizing (amortizing is the systematic repayment of a loan) even if the buyer makes all his payments on time he's still going to have a balance 360 months later! This problem gets worst as the days to the first payment go over 30, and they could go as high as 61 days.

The solution to this problem was for the lender to collect a one time pre-payment of interest at closing in an amount sufficient so that there is never more than 31 days interest due when the first payment is paid. This solved the problem when the buyer makes his 360 payment (adjusted for the pennies that had to be rounded off each month) his loan is paid in full!

Then along comes RESPA, The Real Estate Settlement And Procedures Act and with it the "Good Faith Estimate" and "Truth in Lending" forms. At the time this came out many lenders doing consumer loans were still writing "Prepaid Interest loans" these nasty loans added the interest to the principal and that was your balance. If you got $1,000.00 for 3 years at 21% the loan balance would be about $1,310.76 and each month you would pay $36.41 and the balance would be lowered by the full $36.41. (Please don't call me on these numbers, it's been since 1970 since I've seen one of these beasts.) So HUD included Pre-Paid Interest in the calculation of the APR, even though I've never seen a mortgage written this way. Because this is still in the APR many lenders will only show 1 days pre-paid interest on their original "Good Faith Estimate" this is legal but depictive.

Honest lenders will show 15 to 30 days pre-paid interest on their "Good Faith Estimates" because they can't possible be sure when the loan will be funded! Showing one days interest of $17.81 keeps the APR lower, but falsely shows the dollars need to close much lower than showing 30 days interest of $534.30! That $516.49 difference can really hurt and surprise the home buyer at closing! In my market with a more typical $350,000.00 loan that's could be as much as $1,807.72 in unanticipated closing cost. Non-conforming (sub-prime) buyers had best have an EMT standing by.

Personally I recommend disclosing 25 days pre-paid interest because if a loan is closing in the first week of the month we can now normally get a credit as opposed to a charge and have the payment come due on the first of the very next month. I don't want the buyer being shocked and needing extra money at closing.

Bill

William J Archambault Jr

The Real Estate Investment Institute

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