Truth-in-Lending and APR


The Truth-in-Lending Act (TILA)


The Truth-in-Lending act is one of the most critically important consumer protection acts in the mortgage business.  In order to protect consumers, it requires complete disclosure of all credit terms, the consumer costs of obtaining credit, and the rules that will protect consumers when they borrow using a home as collateral.


Truth-in-Lending regulation has a noble purpose.  It is designed to allow the borrower to comparison shop loan programs and the over all cost of credit while providing protection from inaccurate and unfair advertising.  Unlike the “Good Faith Estimate” which discloses the entire transaction’s cost, Truth-in-Lending deals only with the cost of the loan.


Purposes of TILA




The Truth-In-Lending Disclosure


The Truth-In-Lending Disclosure Statement (TIL) should be given to the consumer at the time of application.  If it is not, the lender has three business days from the date of application to mail the disclosure to the borrower.


The APR calculation may confuse the lenders and buyers alike.  “Annual percentage rate” sounds a lot like “interest rate” to most borrowers.  The APR is not an interest rate, but a theoretical measure of the cost of credit expressed as a percentage rate.


The purpose of the APR is to provide consumers with a uniform measure of the cost of a loan.  The APR equation includes the contract interest rate and adds the costs of the loan, including any prepaid costs (points, fees, etc.) that are part of the cost of borrowing.  Ideally, borrowers can compare costs from company to company by comparing the APR.


The APR Formula



Amount Financed

Total of Payments





The cost of your

The dollar amount

The amount of

The amount you will have

Credit as a yearly

the credit will cost

credit provided to

paid after you have



you or on your

made all payments




as scheduled.

   4  %

$            3

$              2

$              1




  1. Compute total of payment by multiplying payment schedule, including PMI by amount of payments.
  2. Amount Financed is the loan amount, less points, prepaid interest, PMI, and lender fees
  3. Finance Charge is the Total of Payments less the Amount Financed
  4. Compute the APR by dividing the Total of Payments by the number of payments and apply that against the Amount Financed, as if it were the loan amount


The first step in determining an APR is to subtract the prepaid finance charges from the loan amount.  The result is the “amount financed.”  Next, the full principal and interest payment (including Private Mortgage Insurance or PMI ) is applied against the “amount financed” as if it were the loan amount.  The resulting interest rate is the APR.



Determining the Amount Financed-What are Finance Charges?


A prepaid finance charge is any charge one must pay in exchange for obtaining a loan (charges you would not incur if you were paying cash for the property).  Like the APR, it can be used by consumers as appoint of comparison between lenders.  Finance charges include loan fees (discount points, origination few, PMI) and miscellaneous fees (tax service, underwriting, document preparation, or lender review few).


In addition, some prepaid items such as per diem interest and escrows for PMI or prepaid PMI, FHA upfront MIP (Mortgage Insurance Premium), and the VA (Veteran’s Administration) funding fee are considered finance charges.  Other prepaid items, such as association dues, are not included.


Appraisal and credit report fees are not included when they are collected as part of an application fee.  Any inspections (termite, well, septic, etc.) that are required by lenders are not considered finance charges.  Fees for recording a deed of trust are not included either.  The only exception is a construction loan draw inspection. 



Third Party Fees


Regulation Z (12 CFR 226.4(b).) lists the following charges from third parties as examples of fees that the creditor must include when calculating the finance charge:


·        Interest, time-price differential, and any amount payable under an add-on or discount system of additional charge

·        Service, transaction, activity, and carrying charges

·        Points, loan fees, assumption fees, finder’s fees, and similar charges

·        Investigation and credit report fees

·        Premiums on insurance protecting the creditor against the consumer’s default

·        Charges imposed on a creditor by another person for purchasing or accepting a consumer’s obligation

·        Premiums or other charges for credit life, accident, health, or loss-of-income insurance, written in connection with a credit transaction

·        Premiums for homeowner and liability insurance written in connection with a credit transaction

·        Discounts to induce payment by a means other than the use of credit

·        Debt cancellation fees



Fees Excluded from the Finance charge



Insurance and debt cancellation coverage can also be excluded if the coverage is not required by the creditor, the premium for the initial term of insurance is disclosed, and the consumer signs or initials a written request for the insurance.  If itemized and disclosed, certain taxes and fees prescribed by law are also excluded from the finance charge.


Explaining the amount financed would be much simpler if each loan came with an “itemization of amount financed.”  The itemization would include a detailed list of the loan amount, the payment schedule, and each finance charge.



Payment Schedule


The payment schedule is another factor in calculating your APR.  To determine the payment amount to apply against the amount financed, divide the total of payments by the number of payments and use this average amount.  On a fixed-rate loan, the payment schedule is quite simple-the monthly payment is the same through the life of the loan.  Variable payments (as in an ARM, Buydown, GEM, or GPM) may be more complicated on a payment schedule.  The APR or ARMs can change based upon future interest rate changes.  Buydowns, GPMs, and GEMs have fixed payment schedules, so the APR on these loans will not change.



Total Finance Charge


The APR, amount financed, and total of payments have all been calculated—what is the total finance charge?  The difference between the total of payments and the amount financed represents the cumulative total of all interest and prepaid finance charges accrued on the loan, or the total finance charge. Subtracting the amount financed from the total of payments reveals this number.