APR's - what do they mean and should they concern me?

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The Independent Online

The APR or Annual Percentage Rate to give it it's full title was originally introduced under the Consumer Credit Act 1974. The idea of the APR was to give the consumer a quick and easy way to compare the cost of credit from one lender with another. This method of calculation has served reasonably well in providing a direct comparison for borrowings such as personal loans and credit cards. However, there are a number of flaws in the way in which the calculation can be made which means that it not so reliable when comparing one mortgage with another.

The APR or Annual Percentage Rate to give it it's full title was originally introduced under the Consumer Credit Act 1974. The idea of the APR was to give the consumer a quick and easy way to compare the cost of credit from one lender with another. This method of calculation has served reasonably well in providing a direct comparison for borrowings such as personal loans and credit cards. However, there are a number of flaws in the way in which the calculation can be made which means that it not so reliable when comparing one mortgage with another.

The APR has to be quoted whenever the headline rate of interest is quoted and is usually shown after the main rate. Because the APR takes into account the set-up costs for a mortgage it will always be higher than the main rate quoted.

The concept of the APR is that all initial fees should be taken into account and reflected in the true annual interest rate. In addition the APR will reflect the way in which interest is charged to the mortgage account (i.e. annually, daily etc). In theory this should then enable the consumer to make a direct comparison between one lender and another. Unfortunately, mortgages are generally more complex in their set up than unsecured loans or credit cards and a number of variables can lead to misleading rates being shown. For example, the APR should take account of any initial fees such as mortgage indemnity premiums, valuation fees and any arrangement or booking fees. However, it is possible for lenders to avoid including the mortgage indemnity premium in their calculation by assuming a low loan to value ratio. This means that if you are applying for a 95% mortgage then the true APR rate in your particular circumstances could be higher than that quoted in general advertising literature. In addition, valuation fees are usually calculated on a sliding scale with a higher fee for more expensive properties. Again it is possible to assume a low property value in the calculation, thereby reducing the cost of the fee.

The largest area for confusion, however, comes when considering a discounted, fixed or capped rate mortgage. With this type of product the fixed or discounted rate will invariably last for only the first few years. One would assume therefore that the APR calculation would take into account the introductory rate for the initial period and then be calculated using the standard variable rate thereafter. Unfortunately, this is not always the case and it is possible to assume that the introductory rate lasts for the duration of the mortgage. This means that APR calculations when used in conjunction with mortgages are at best confusing and at worst downright misleading.So, where does this leave the consumer? How can you accurately compare one mortgage with another and make sure you are getting the very best possible deal? Well, there are a number of steps you can take to protect yourself. First of all you could ask individual lenders to quote you the APR using your own specific circumstances rather than the general example used in their advertising literature. This will mean that any mortgage indemnity premium will have to be included and a true valuation fee figure will be added. In addition you should ask the lender to quote using their standard variable mortgage rate at the end of the initial incentive rate period. You should also ask all lenders to quote you the APR using the same mortgage term. If you do this you should start to get a more accurate picture of the mortgages you are considering.

The other alternative is to look at three separate factors when considering which deal to take. First consider the headline rate of interest, then look at how the lender charges interest to the account (i.e. annually, daily) and finally consider all the other costs associated with the mortgage. If you take this approach you soon be able to see which lenders are offering you the best deals. I have listed below the costs you are likely to incur in connection with your new mortgage and I hope this will be a help when in discussion with lenders;

  • Mortgage arrangement or booking fees (these are sometimes payable up front with the mortgage application, and sometimes added the mortgage debt when it is taken out. If the fee is payable up front check to see if it is refunded if the application does not proceed - you will often find that you will lose this fee if your application does not proceed so it is important to check the terms at the outset).
  • Valuation Fees - Don't forget that it may be cheaper to ask the lenders surveyor to carry out a survey on your own behalf at the same time as the mortgage valuation rather than arranging your own separate survey.
  • Mortgage Indemnity Premium - Also called mortgage guarantee premium, insurance guarantee premium, higher advance fee and a host of other fancy titles. This fee will be triggered if you wish to borrow above a certain percentage of the property value (typically these days 90% although some lenders still trigger the premium at lower loan to value ratios). Ask the lender at what point the premium is triggered and see if you can avoid it altogether or pay it at a lower rate by borrowing slightly less. For example, if you are looking for a 92% mortgage it may pay you to reduce the advance to 90% and avoid the premium altogether.
  • Buildings insurance premiums - ask the lender to provide you with a quote and find out if it is compulsory to take that cover through the lender or whether you are free to arrange the insurance yourself. If you are not required to take the insurance from the lender as a condition of the mortgage then it is worth shopping around.
  • Other compulsory insurance costs - If it is a condition of your mortgage that you take contents insurance from the lender then get a quote for the cost of this and compare it with other quotes that you can get yourself. Take this into account when considering the relative value of the mortgage deal.
  • Redemption penalties - Check the terms that apply to early redemption of your mortgage and if you think it is likely that you may wish to repay the mortgage whilst penalties still apply then take this into account in your initial calculations.

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