To start with, consider two lenders who charge 8 percent in interest on a $100,000 loan. Lender A also charges 3 points but does not charge the borrower any fees for taking the application, doing an appraisal, etc. Lender B charges only 2 points, but charges the borrower $1000 to cover the application fee, credit report, appraisal, etc.
In this example, the borrower's expenses are identical with the two lenders: 3 points, or $3000 up front, and 8 percent interest over time. However, lender B would be allowed to quote a lower APR, based on 8 percent plus only two points. Lender B's fees can be separated out and not included in the APR.
To calculate the APR for a loan with points, go through the following steps:
Now, the APR is the interest rate that would amortize the original balance of $100,000 using the monthly payment we just calculated, of $755.78. We solve for the APR the way we solve any high-order polynomial: by repeated guessing. If we plug in 8.3 percent and a balance of $100,000 into the mortgage payment calculator, the monthly payment comes out below $755.78. If we try 8.4 percent, it comes out high. If we use 8.31 percent, it comes out at $755.49, which is as close as we can get without taking the APR out to three decimal places.
The APR calculation pretends that we amortize points over the life of the mortgage. Because of this, it is unwise to compare APR's on mortgages with different terms, for example a 30-year term compared with a 15-year term. If both loans charge the same number of points and the same interest rate, the 15-year loan will have the higher APR (in our example, it would be 8.51 percent).
Other regulatory points of note:
Then, I would use the Intelligent Mortgage Agent (TM) or the mortgage analysis worksheet to see how the loan would work and to compare it with other loans.
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