Question

Ed wants to buy a property for $320,000 and wants a CPM loan for 80%. A lender indicates the loan can be obtained for 30 years at 5.5% with an origination loan fee of $1,200 and 2 points.

If Ed repays the loan after five years, is the effective interest cost different from the APR? If so, why?

The effective interest cost is the same as the APR. Although there was less time over which to spread the origination loan fee and points, the prepayment penalty caused the rate to decrease. Therefore, the increase caused by the fee and points is canceled out by the decrease from the prepayment penalty, and the rate remains the same.

The effective interest cost is higher than the APR because the prepayment penalty allows the bank to increase the interest rate on the loan.

The effective interest cost is lower than the APR because there was less time over which to spread the prepayment penalty. The origination fee and points will not effect the rate because they do not change.

The effective interest cost is higher than the APR because there was less time over which to spread the origination fee and points. Also, the prepayment penalty causes the rate to rise.

The effective interest cost is lower than the APR because there was less time over which to spread the origination fee and points. Also, the prepayment penalty causes the rate to decrease.

Answer 1

Answer : The effective interest cost is higher than the APR because there was less time over which to spread the origination fee and points. Also, the prepayment penalty causes the rate to rise.

Explanation : Effective rate is higher than APR because of many reasons

First : Net loan amount will reduce as origination fee is deducted from loan amount.

Second : you have to pay for points, so you have to pay extra amount with loan amount

So though interest is calculated on loan amount, the amount usable decreases and repayable increases

Third : there is also prepenalty payment, so indirectly you are paying more, so effectively cost is higher

Fourth : As we are repaying loan earlier, there is a less time to spread origination fees and points, which also increases cost.

So effective rate is always higher than APR if origination cost, points and prepayment penalty is there on earlier repayment