How to separate face rate from annual percentage rate

Can you explain the difference between face rate and annual percentage rate (APR)?

The face rate for a loan is the amount that will appear on your promissory note. It does not take into account additional borrowing costs and certain lender-required fees and expenses. Suppose you borrowed US Dollars 100 for one year and paid US Dollars 106 at the end of the year. Your interest rate is 6% - that is pretty easy. What if, instead, you had to pay a US Dollars 10 fee for the lender to evaluate your loan request and fill out some paperwork? In that case, the loan cost you US Dollars 10 in advance, and US Dollars 6 at the end. The real cost of that loan is much greater than 6%. That is what the APR calculation attempts to reveal to you.

If First National Bank will charge you 7.5% interest with no closing costs or loan fees, that might be cheaper, overall, than Last State Bank, which quotes you 7% interest but with thousands of dollars in loan fees that must either be paid at closing or included in your loan. The mechanism that allows you to compare your options in this situation is something called the annual percentage rate (APR). You should ask all potential lenders for their estimate of the APR on your loan, and an itemized list of loan fees and expenses you can reasonably expect, with an estimate of the amount.

How can I reduce my interest rate?

Aside from competitive shopping, several things will reduce your interest rate among almost all lenders. The following are some general rules of thumb.

The larger your equity in the property, the lower your interest rate will be, because the lender has a smaller risk of loss due to foreclosure.
A loan with monthly principal and interest payments will have a lower interest rate than one that calls for interest payments only, with the principal due some time in the future.
Better credit scores qualify you for cheaper interest rates. Even if your credit score is good enough to obtain a loan, see if improving it might reduce your rate.
The shorter the loan term, the lower you can expect your interest rate to be. Generally speaking, a 15-year mortgage will have lower rates than a 30-year or 50-year mortgage.
Some lenders will give you a cheaper rate if you already have other loans with them or agree to place your checking account with them. Be aware, however, that some lenders will require you to keep your property operating account with them as a condition of the loan. This is so they can keep track of the money in the account and have a possible early warning if you are headed into financial trouble.
Paying loan points (different from origination points) will allow you to "buy down" your interest rate. For example, a lender might say, "You qualify for 8.25% interest. But, you can pay a fee equal to 2% of the loan, and we can reduce your rate to 8%." You will, however, have to make your own determination.

Can I avoid personal liability for the loan?

Most lenders will require beginning investors to sign the mortgage loan with full personal liability in case there is a default. If you are buying property in the name of a corporation or similar entity and the loan is in the same name, the lender will usually ask you to guarantee the loan. The lender wants to know that you have some "skin in the game." In other words, the lender wants you just as worried as he or she is in regard to paying the mortgage on time every month. If you have nothing at risk except the loss of your down payment, you might decide to walk away and let the lender foreclose if there are problems.

If you are a financially strong borrower with an excellent reputation, or if you are experienced and known to your lender, you can avoid personal liability in two ways. One is by borrowing the money in a corporate name and not guaranteeing the note. If the corporation has only one asset - the property you bought - then the most you will lose in a financial disaster is the property. The lender will not be able to sue you in case foreclosure does not pay off the loan completely. The other method is to tell the lender that you want the loan to be non-recourse, or a dry mortgage. The documents will need to specify that you will have no personal liability in the event of default. Surprisingly, it is much easier to obtain non-recourse financing with larger loans - those in excess of US Dollars 3 million. It is also much easier to obtain 100% development financing for larger loans. It is something to think about as you become more confident in your investing skills.

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