If you or someone you know is thinking about getting a home mortgage, you may want to know about the thousands of dollars in hidden charges that some lenders are quietly adding to mortgage loans after they show potential borrowers the initial terms of the loan.
A friend of mine who buys property regularly in Austin, Texas recently showed me this when he discovered on closing day that he'd have to pay a staggering $30,000 more in interest than what his bank promised him on the initial term sheet.
James had found a home he loved near downtown Austin and decided to take out a mortgage. The bank showed him how much his mortgage's annual percentage rate (APR) would be in his initial term sheet along with all the other usual fees like closing costs and taxes. Everything seemed normal, so he went ahead with the mortgage process as any home buyer might.
But everything changed at closing time. After months of paperwork and preparation for the big day, James was finally presented with the official loan paperwork, where he found the bank was calculating his mortgage's interest rate over 360 days instead of 365 days, jacking up his APR well above the rate the bank originally quoted him.
This deceptive rounding trick is called the "Bank Method" interest calculation (aka the 360/365 Method), and it's how many lenders can get away with piling thousands of dollars in unexpected interest charges onto mortgage loans as late as closing day while borrowers are busy signing mountains of pages to get their new home.
But that doesn't mean you have to be the next victim. Here we'll show you how the Bank Method interest calculation works and how to avoid paying it.
How the Bank Method (or 360/365 Method) Interest Calculation Works
To pull off this sneaky mortgage trick, the lender takes the APR it quoted you and divides it by 360 to calculate the daily interest rate. This makes the daily interest rate larger, because the promised APR is divided by 360 instead of 365.
From there the lender multiplies that number by 365, charging you the inflated daily interest rate for 365 days (or 366 days for leap year).
Then they have the nerve to hide it in your closing-day mortgage paperwork -- you know, the giant pile of paper you don't actually have time to read as you're signing in a mad rush to get some keys?
How Much Could the Bank Method Interest Trick Cost You?
You can calculate how much a lender may (over)charge you for interest by using the Bank Method interest calculation yourself.
Bank Method interest calculation = (Your Promised APR / 360) X 365
For example, let's say you were looking to buy a $350,000 home and the mortgage lender quoted you 6% APR. If the lender used the 365/360 method of calculating interest, the home loan would in truth carry an interest rate of 6.083% (or .06 / 360 X 365).
By plugging in these rates into a mortgage calculator, you'd find that the 6.083% manipulated rate would tack on an extra $6,736 in interest charges over the life of a 30 year fixed-rate mortgage (i.e. $412,170 in total interest at 6.083% APR versus $405,434 at 6.0% APR)!
That's almost seven grand the lender didn't even tell you about when it enticed you with the loan originally.
But it's even worse when you look at how much you could have done with that money. For example, if you had invested that $6,736 in stocks over the course of 30 years and earned an annual return of 8%, that money would grow to a whopping $27,885 according to some savings calculator math.
I don't know about you, but I think that's way too much money to miss out on from a dishonest "rounding trick" that the lender put in at the last minute.
The Investing Answer
While this controversial interest calculation is still legal for lenders to use, that doesn't mean you have to be the next victim and pay it.
Before it gets to closing day (and preferably when you first apply for a mortgage loan), ask your potential lender if they calculate your daily interest rate using "Bank Method" or the "365/360 Method." If they do, ask if this will change the annual percentage rate they originally quoted you, and be prepared to walk away if it increases your rate.
When tens of thousands of dollars are on the line, it's not worth letting them get away with this trick. After all, there are plenty of other lenders willing to help you with your mortgage without deceiving you at the last minute.