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Total Interest Percentage… Whaaat?

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Posted On: 06/22/2016

Question:

We received a Loan Estimate from a lender while we were shopping for a mortgage. At the back was a calculation for something called the Total Interest Percentage. Which is better for comparing loans, a TIP or the APR?

Answer:

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Both the TIP and the annual percentage rate (APR) are ways to estimate mortgage costs. There are advantages and drawbacks to each.

When you shop for a mortgage you want the lowest rate, say 3.75 percent rather than 4 percent. However, the interest rate does not represent the full cost of borrowing. Several up-front charges, including points and various fees, are part of the financing expense. While the interest rate is the annual cost to borrow, the APR shows the cost to borrow over the loan term when the lender’s fees and charges are included.

The Total Interest Percentage is something new. According to the Consumer Financial Protection Bureau, the TIP tells you how much interest you will pay over the life of your mortgage loan, compared to the amount you borrowed.

For example, if you have a $100,000 loan and your TIP is 50 percent, that means that you would pay a total of $50,000 in interest over the life of the loan, in addition to repaying the $100,000 that you borrowed. If your TIP is 100 percent, that mean you would pay $100,000 in interest (100 percent of the $100,000 loan amount) over the life of the loan.

For virtually all borrowers, these measurements describe something that will never happen. How many people do you know who have had the same mortgage for 30 years? The answer is pretty much zero. Thirty years ago was 1986.

The real issue concerns what is called “tenure.” According to the National Association of Realtors, in 2015 the typical home was owned for nine years. If the typical home is owned for nine years then it follows that the mortgage is unlikely to last any longer unless assumed.

Let’s say Smith borrows $200,000 over 30 years. The interest rate is 3.75 percent fixed. If Smith pays $5,000 in fees and charges the annual percent rate will be 3.93 percent over 30 years. Let’s say we use a more realistic timeframe – nine years. Now the APR rises to 4.27 percent, because the $5,000 is being accounted for in less time.

The Total Interest Percentage calculation is similarly unrealistic. Since few people will have a loan that’s outstanding for 30 years, the TIP is like the edge of the universe – a place far, far away that we will never reach.

Nobody knows how long they will own their home. Not only that, because of refinancing and home sales, nobody knows how long their present mortgage will be outstanding.

So yes, both the APR and the Total Interest Percentage are on the new form. In practice, however, most people will look at the interest rate and the loan costs in order to compare financing expenses.

Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to peter@ctwfeatures.com.

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