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Second Mortgage Rate and APR
 Scott,
Why is it a different price for the
quoted loan interest rate, my mortgage company Quicken Loans, quoted me
6.55 percent on a second. Then when I get the papers to sign, the APR fair
credit paper states 7.1 percent for the interest rate. Is the mortgage company
trying to be dishonest and not really give me the rate quoted? I don't
understand; please help me. Thank you!
Pam
Pam,
Thanks for writing in with a math question!
I do so enjoy talking about the math of
money because math is the tool you need to uncover the truth about the
cost of debt. Math enables you to compare your credit options and avoid
being fooled by the banks!
Here it is in a nutshell...
 The APR you were originally quoted,
6.55 percent, is the interest rate that the bank uses to charge you monthly on
your outstanding balance. That is, 6.55 percent divided by 12 is
0.5458333 percent.
Therefore, if your outstanding balance is $10,000, then you will be
charged $54.58 in interest at the end of the month, which brings the
total balance to $10,054.58.
The 7.1 percent rate in the final paperwork
takes into consideration all fees associated with the loan. It is the
true interest rate you pay on the loan based on the amount of money you
receive versus what you repay. This number is important because it allows
you to compare one loan against another, apples-to-apples.
Let's say you want to borrow $30,000 for
your second mortgage and the repayment time is 15 years. The interest
rate quoted is 6.55 percent, but there are other associated costs like a $315
application fee, $500 appraisal fee, and $200 in legal fees. The total
of all these fees is $1,015.
Using my DebtSmart
Loan Calculator, a $30,000 principal, for 15 years, at 6.55 percent, gives
a monthly payment of $262.16. But here's the deal--you don't get the
entire $30,000!
Why?
Because you have to pay $1,015 to get the
$30,000! That means you really get to use $28,985. But your monthly
payments are still going be $262.16. Since you're actually using less than
$30,000, which is the principal used to compute the monthly payment, it's
clear that the true interest rate is higher than the quoted rate. To find the true rate you need
to ask the question, "What interest rate is used on a $28,985
principal, for 15-years, to arrive at a
monthly payment of $262.16?
Again, using the DebtSmart
Loan Calculator, you will find that rate to be 7.1 percent.
So the bottom line is that they're not
lying to you. They're fulfilling the legal obligation to compute the
true interest rate with all fees included.
Cheers,
Scott
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