Does APR or Annual Percentage Rate include PMI?

Scenario:

I locked a fixed rate mortgage with XYZ Company for 6%. The closing costs came out to be 5.5K and no additional fees or points were charged.

When I got the Truth-in-lending disclosure, the APR came out to be 6.85%. I called my lender and they informed me that the reason for the increase was PMI. Can PMI raise my APR from 6% to 6.85%? I checked through the loan application doc and good faith estimate but couldn't find any hidden charges. Can you explain this change in APR?

Solution:

APR or Annual Percentage Rate reflects the true cost of a mortgage loan. APR does include the PMI or Private Mortgage Insurance apart from the loan-processing fee, underwriting fee, document preparation fee and other costs.

Let's take an example: If you take out a 30 year fixed rate mortgage worth $200,000 at 6% and pay closing costs worth $5500 including the PMI payment of $1000, then the net amount you borrow is $194,500. However, your loan balance at the beginning is $200,000. The APR is the interest rate on the net amount borrowed, that is, $194,500. This rate will yield the same monthly payment as the mortgage interest rate of 6% on the loan amount $200,000.

However, if you calculate APR using the APR calculator, in your situation, it will come out to be around 6.25%. But your lender is charging a higher APR, that is, 6.85%. I don't think just the PMI can raise the APR by 0.6%. However, you need to ask the lender as to what extra fees he has included in the APR. Check if he has included costs such as loan application fee, credit life insurance and others.

Now, let's take an example to show how APR becomes higher than the mortgage rate.

The APR is usually higher than the interest rate on your loan. Say for example, if you take out a 30 year fixed rate mortgage worth $150,000 at an interest rate of 8.5%, the monthly payment will come out to be $1153. Now, suppose you pay 2 points amounting to $3000, processing fee of $600, appraisal fee of $300 and credit report fee of $100. The total closing cost then amounts to $4000. The APR is calculated to be 8.79.

Now the net amount borrowed equals $146,000 ($150,000-$4000). The interest rate on the net amount which gives the same monthly payment of $1153 would be 8.79.

Author: SAMANTHA TAYLOR