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Learn how a Mortgage Rate, APR and Total Interest Rate (TIP) are calculated on your mortgage loan.
To help you understand the difference between a mortgage rate, annual percentage rate (APR) and total interest percentage (TIP) we have created some examples to help you visualize the process.
The interest charged over the life a loan. For example, a 30-year fixed rate mortgage of 3.5% would mean that the interest rates and the monthly payments based off of this rate will be fixed for 30 years.
APR stands for Annual Percentage Rate which is the annual cost for financing a loan with fee's included. An APR higher than your Mortgage Rate means you are paying fees. The charges may include points, administration fee, private mortgage insurance, pre-paid interest, etc. However, not all lenders include the same fees in the APR as each lender prices their products differently.
TIP stands for Total Interest Percentage, which gives you the total amount that you will pay in interest over the life of the loan, shown to borrowers in the form of an overall percentage point.
Example of How to Calculate APR
Note: Your monthly payments are based on your fixed rate and NOT the APR.
Example of How to Calculate TIP
The example above shows both the Interest Rate and the APR. In both cases the APR is higher because it includes all fees associated with the loan. Notice that the total interest rate is higher once you calculate the total amount that will be paid over the life of the loan, in this case, over 30 years. This is calculated by taking the interest divided by the loan amount.
Here is an example of Total Interest Paid (TIP) by month to show how it can be really high.
TIP is always going to be higher because it is including everything that you will pay in the life of the loan. The true interest rate in the table above should decrease with time as additional monthly payments are applied to the principle.
Here is a complete picture of the true interest rate of a $200,000 mortgage loan at 3.75% for 30 years in an amortization schedule below.
In summary, your TIP would be 40% for the life of the loan, in addition to repaying the $200,000.00 you borrowed. So, when you're applying for a loan and receive your loan documents you should see the TIP somewhere as it is a new requirement for all mortgage lenders to disclose TIP. If you cannot see it, ask your Loan Officer. It will look something like this:
1. Are Mortgage Rates and APR the same?
No. A mortgage rate is the rate interest charged for borrowing a loan and the APR includes your mortgage rate plus any financing costs.
2. Do all lenders include the same costs in the APR?
Different lenders have different loan products and therefore may not include the same financing charges. It is up to the lender to decide which charges to include as part of the Annual percentage rate (APR).
3. Are fixed mortgages and adjustable rates APR calculated the same?
The calculations on an adjustable rate mortgage are unpredictable because the loan is shorter and the rates can go up or down. Therefore, you have to account for the time the rates changes. It's easier to calculate the APR on a fixed rate because you are assuming that you will hold your loan for a longer period of time.
4. How does knowing my APR help me?
It allows you compare loans and gives you a picture of which loan is better from which lender. However, it can be confusing at times because not all lenders include in the same fees in the APR and therefore it is important for you to ask your lender and find out what goes into their APR calculation, then compare side by side.
5. Do all lenders advertise the APR when searching for loans?
By law, lenders are required to advertise the rate and the APR. So, if you're shopping for a loan you should be able to see both similar to the image below. If you only see the rate and no APR, move on.
However any loan that does not have an APR means that they are not charging you to finance the loan but it doesn't mean that you are not paying it on back end by charging you a higher interest rate. Most likely you are paying for it. Even still, the lender should clearly indicate the APR in any case.
6. Are APR's always accurate when getting a quote?
No, but they should. When you are being quoted for a loan, lenders will include an APR in the quote. However, it doesn't mean that the APR will stay the same as you move forward into the loan process. APR's being quoted to you is only a starting point to get you to understand how much the loan will cost you. But you have to take into consideration things like; what happens if I refinance or make an extra payment?
7. Should I shop for an interest rate or APR?
The short answer is that you should look at both. Most people shop for an interest rate first because that's what their monthly payments are based off of, and then they view the APR to drill down into what their costs may be.
8. Is there such a thing as ZERO APR Mortgage?
If you ever see a zero APR it is most likely a promotion to get your business. APR cannot be zero for mortgages. Zero APR is typically a promotion for credit card offers, not mortgages.
9. Is TIP calculated the same on Adjustable Mortgage Loan?
For an adjustable rate you have to look at when the loan rate changes. For example, if the you get 5-year adjustable rate at 2.75% and after the 5 years the interest are lower, then the total interest rate would change because your rate is being reset.
10. Why is TIP so high in my Mortgage?
Again, TIP will always be high because it is the true total interest percentage paid over the life of the loan. You can always lower your TIP by applying more money towards your monthly mortgage payments to reduce the time it takes to pay off the entire balance.
Understanding your Mortgage Rate, APR and TIP is only the beginning when selecting which mortgage loan you can afford. Remember that things can change as you go deeper into the approval process with your lender. Therefore, you should ask your lender questions to help you understand the final fees associated with your loan.
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