How To … Effectively Explain the Difference Between the Note Rate and the APR!

One of the loan originator’s most frequent challenges is adequately explaining the difference between the mortgage loan’s actual interest rate and the Annual Percentage Rate (APR). Upon discovering the APR on the Loan Estimate (LE), the customer may suspect that the loan originator locked in their loan at an interest rate that’s higher than the one upon which they agreed.

To manifest happy and trusting customers, it is imperative to anticipate and adequately address this issue prior to the consumer receiving the LE. Simply assuring your customer that the APR is not the rate at which their payment will be calculated is insufficient. After all, why should they believe you? Or, even if they do believe you, wouldn’t you prefer that your customers thoroughly understand the process versus simply taking your word for it? Trust needs to be earned. The way to effectively explain the differing rates to a customer is relatively simple. And, by taking this extra step, you’re one step closer to establishing that well-coveted trust.

Start off by explaining that the government requires lenders to disclose a loan’s annual percentage rate to all mortgage customers for comparative shopping purposes. The APR is simply the cost of originating the loan expressed as an interest rate and NOT the rate at which the customer’s payment is calculated. Continue by sharing how, because the government wants to make it easy for consumers to comparatively shop various lenders, it requires all lenders to disclose the interest rate associated with the sum total of the standard interest to be incurred at the agreed-upon interest rate plus certain settlement costs associated with originating the loan that is incorporated into the financing and not paid by the borrower out of pocket prior to or at the closing table.

To ensure the consumer’s understanding in addition to their knowledge, elaborate by offering them the following example. Prepare and show the customer an amortization schedule describing a loan amount of $200,000 at 6.0% fixed for 30 years. Point out how, in assuming the borrower satisfied the loan through 360 monthly payments (30 years), he or she would ultimately spend the original $200,000 principal balance along with an additional $231,676 in interest for a grand total of $431,676. Next, exemplify the APR’s significance by using an estimated settlement cost expense of $5,000. Then, to ensure their understanding, ask the customer to identify the variable that would have to change in order for the borrower to spend the sum total of the original principal balance plus the normal interest expenditure at 6% plus the $5,000 in settlement costs for a grand total of $436,676 if there were no closing costs and if the original loan amount and term did not change.

To this, the customer should logically conclude that, if the original loan amount and term did not change, the only variable that could cause a greater overall expenditure would be a higher interest rate. Voila! THAT is the purpose of the APR. Deductively, therefore, if two identical loan options explored through two different lenders disclosed differing APRs, it would be accurate to say that the lender offering the loan with the higher APR was charging higher settlement costs. That is how the consumer uses the APR to comparatively shop. It has nothing to do with the rate at which the loan’s payment is calculated.