APRs tell you nothing about ARMsand very little about fixedrates

The Federal Reserve board and the Office of Thrift Supervision have published a booklet called Consumer Handbook on Adjustable Rate Mortgages, available online atwww.hsh.com. Unfortunately, this Handbook reinforces numerous widely held misconceptions about mortgages. Consider this advice given in the handbook:

Because all lenders follow the same rules to ensure the accuracy of the annual percentage rate (APR), it provides consumers with a good basis for comparing the costs of loans.

When you compare the costs of mortgage loans, you will see the term annual percentage rate (APR). To comply with government truth-in-lending laws, mortgage-interest-rate advertising must include this figure. The APR always exceeds the stated interest rate because it supposedly accounts for your total cost of borrowing (interest, fees, points, and certain other expenses). Supposedly, compare APRs among various loan products and lenders and you find the lowest-cost loan.

Real life proves more complex. APRs that apply to ARMs make no sense. Under the law, these APRs are calculated as if the ARM interest rate will not change during the full life of the loan (except for the scheduled boost up from the teaser rate to the initial contract rate). Yet, the very idea of an adjustable-rate mortgage means that the interest rate will change. So, APRs for an adjustable-rate mortgage gives us mathematically precise yet irrelevant figures. No one can accurately predict the APR for an ARM.

In an effort to force lenders to tell the truth about the costs of their mortgage loans, the government misleads borrowers. To compare ARMs, you cannot rely on the stated APRs. You may find a COFI ARM with an APR of 7.86 percent and a one-year Treasury ARM at an APR of 7.21 percent. But because no one knows how these respective ARM indexes will change over time, the APR does not tell which one represents the lowest-cost loan.

Contrary to what the Fed's customer booklet says, mortgage lenders do not compute APRs in lockstep with each other. The law remains ambiguous on many types of expenses—and some lenders take advantage of this fact to lowball their APRs. Ignore the ARM's APR. It means nothing to consumers.

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