Q We have been reading your column for a long time and share your concerns about shopping around for the best deal in a mortgage. Recently, we applied for a mortgage loan. Although we thought we were getting a 9 7/8 percent loan, the truth-in-lending statement indicated that the annual percentage rate was 10.2 percent. How can we accurately compare prices when the tools for competitive shopping are unclear and, indeed, confusing?
A When Congress enacted the truth-in-lending legislation back in 1969, there was great expectation that, once and for all, the consumer would be able to comparison shop by virtue of the actual annual percentage rate (APR) -- the true interest on a loan. All too often, before the truth-in-lending law, lenders would quote rates that were completely misleading.
For example, when an auto loan is quoted at 6 percent "discount," the true simple interest rate is really 11.85 percent per year. If that same auto dealer quoted a 6 percent "add-on" rate, the true annual percentage rate is 10.9 percent.
Let me give you another example. I lend you $100 at a simple interest rate of 8 percent. At the end of the year, you give me back my $100, plus $8 for the interest.
But suppose, when I lend you the $100, I subtract the 8 percent interest (namely the $8) and only give you $92. Your obligation is to return $100 at the end of the year, payable in equal monthly installments. Here, the true annual rate is not 8 percent, since you have not had the full use of my $100 for the entire year. In this example, the annual percentage rate (the true interest) is 15.68 percent.
Although Congress tried to get away from misleading interest rates, in the mortgage area, at least, we unfortunately have come full circle back to this confusion.
When you gave the example of your 10.2 percentage interest rate, you had to pay points -- the lender's appraisal fee -- and other charges to your mortgage lender.
Insofar as your lender was not advancing you the full amount of the loan (because you will have to pay, up front, the points and other charges), you will not have the full use of the lender's money for the period of the mortgage loan.
Thus, similar to my earlier example, the true interest rate is higher than that which was quoted to you.
Nonetheless, the annual percentage rate can become quite significant. This is the yield to the lender that includes the simple interest rate on your mortgage loan, plus all of the other charges imposed by your lender.
If you shop around, and inquire of other mortgage lenders as to their annual percentage rate, you may find some basis for comparison and some measure of competition.
Another law, namely the Real Estate Settlement Procedures Act, requires that any mortgage lender give you at the time of the loan application a disclosure statement indicating the range of charges that you will be required to pay at settlement.
This statement is a very important document, and you also should use this document as the basis for your comparative shopping.
If your lender has given you a loan commitment, and you have not yet received a copy of the truth-in-lending statement, insist on obtaining it prior to signing the loan commitment. Unfortunately, many lenders give the truth-in-lending statement at settlement, at which time it is a meaningless piece of paper, insofar as comparative shopping is then next to impossible.
There is very little competition among mortgage lenders. Oversimplified, each point that the borrower pays can be equated to one-eighth of a percent interest rate over a period of 30 years. Thus, a lender that offers you a 10 percent rate with three points is, in effect, making you the same deal as another lender that will offer you an interest rate of 10 1/8 percent with only two points.
You have to deterine whether the additional point (which you pay up front at closing) is worth the lower interest rate. There are a number of factors to assist you in making this decision.
For example, if you are going to hold on to the house only for a short period of time, it probably makes sense to pay fewer points and take the higher interest rate.
On the other hand, if you are going to keep the house for a long period of time, then it might make sense to pay more points up front, and take an overall lower interest rate.
You must "do the numbers" before you commit yourself to a mortgage loan. Benny L. Kass is a Washington attorney. For a copy of the free booklet, "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also write to him at that address.