Buying a home is one of the biggest and most important purchases of most people's lives, particularly when you are a first-time homebuyer. If you're buying your first home or simply never paid much attention to the finer points of the mortgage when you've previously purchased properties, the total interest percentage is one of the most useful numbers that you'll get your hands on during the lending process.
A good total interest percentage will often be between 50% and 75%, generally corresponding to APRs that hover between 3.5% and 5.3% as of the time of writing. The further above 75% your total interest percentage is, the less desirable the loan, depending on the lender and loan specifics.
While it should be apparent by now that your total interest percentage will be very important during your house hunt and the lending process, even if you may not understand why. We're going to dive into total interest percentages, find out exactly what they are and what constitutes a good one. We'll also cover just why the total interest percentage is so important and how you can tell if yours is good, even when it seems like the Fed changes rates daily.
What Is a Good Total Interest Percentage?
Deciding what is going to be a good total interest percentage is largely going to be a subjective decision and will also be heavily influenced by what you want out of the mortgage loan. Those planning on completing the loan term will find much more value in the total interest percentage and how it can be used to compare loans between lenders.
For example, homebuyers that simply need a loan now to buy a home may find that they can get more favorable loan terms by taking a hit on the interest or the loan term, which can mean getting their offer to the seller faster and with better terms. If they don't plan to be in the home for very long, they may not mind if they see a total interest percentage of 80% or more. This is also applicable to those who take out a mortgage with the specific intent of paying it off early, provided there are no penalties.
Those that are planning on staying in the home for the term of the loan, or most of it, will find that they should put much more importance on the total interest percentage and should use the number as a reliable way to put lenders' offers on relatively equal footing. While you generally won't see a total interest percentage as low as 15% or 20%, it isn't unheard of for those getting a 5/1 adjustable-rate mortgage to see their total interest percentage down below 50%, and in some cases, even as low as 30% under favorable terms with solid credit.
What Is The Total Interest Percentage & How It Is Determined
Your total interest percentage will be listed in detail on page 3 of your initial loan estimate from your mortgage lender, or all of them if you're getting multiple offers as you should be. If you're looking at your closing disclosure, you'll find the total interest percentage on page 5. The total interest percentage is a crucial point of comparison between your lenders' loan estimates.
The total interest percentage for your loan will tell you the amount of interest that you will eventually pay over the entire life of the mortgage loan in comparison to the total amount borrowed. To calculate your total interest percentage, all of your scheduled interest payments are aggregated and added together, that total is then divided by the total amount borrowed from the lender to get a decimal. This decimal is converted to a percentage, which then becomes your total interest percentage.
There is a caveat to calculating your total interest percentage whether you've yet to take out the loan or if you've already signed on the dotted lines and been disbursed the funds. The calculations are all based on the initial premise that you'll be making all of your scheduled payments exactly on time, as well as the assumption that you'll be keeping the mortgage for the entire term of the loan.
This is a crucial point to understand clearly, since the amount you pay in interest is so closely dependent on time, and that extra time can drastically change how much you're paying in interest charges. While you may not see much difference from one payment that's late by one or two days and accrues a few extra dollars in interest, if this becomes a routine and payments are consistently late it can alter your actual total interest percentage significantly. This becomes even worse if your payments are late by more than negligible margins, and you accumulate even more interest.
Since the total interest percentage is also calculated with the premise that you'll be keeping the mortgage for the entire duration of the loan's term, changing that term by shortening it will also alter your total interest percentage. Assuming there is no prepayment penalty, if you pay ahead on the principal, you are not only reducing the amount owed that accumulates interest, but you're also shortening the time frame during which the interest is charged. This can lead to your original total interest percentage being overstated if you play on paying off your loan in 20 years, but you have a 30-year mortgage.
How Total Interest Rate Differs From The Interest Rate & APR
When people refer to the "interest rate," they are generally talking about the cost to borrow money via a mortgage on an annual basis. What interest rate doesn't refer to, however, is anything related to the total cost of the mortgage. Interest rates are always based on one year.
The annual percentage rate, often seen as APR, is a measurement that includes not only the fees the lender charges to loan the funds but other charges associated with the mortgage as well. The annual percentage rate is the total cost to borrow the money, over the entire term of the mortgage.
The total interest percentage will not take into account any fees or costs, with the single exception of including prepaid interest if the buyer chooses. While the interest rate and the annual percentage rate are calculated and based on one-year periods, the total interest percentage is exclusively used to calculate and reflect the amount of total interest you will pay on the loan over the entire term.
The total interest percentage can often take buyers by surprise when reviewing their loan documents and disclosures. While the interest rate and the annual percentage rate will generally be relatively small numbers, with the interest rate usually being between 3%-6%, and the annual percentage rate would be similar, the total interest percentage will be much larger. It is common to see total interest percentages that range from 40% up to 90%, or even more. Often, the extremely high total interest percentages are only encountered on loans with subprime rates and terms and will quickly be eliminated from the possibilities if the buyer has multiple lender quotes.
How Important Is The Total Interest Percentage?
For borrowers that are going to have fixed-rate mortgages, the total interest percentage can be a vital metric for determining which loan options are going to be more expensive in the long run. If you're planning on buying a home and living there for the entire term of the mortgage loan while making all payments exactly as scheduled in the mortgage paperwork, you should pay particularly close attention to the total interest percentage from one lender to another.
On the other hand, if you are looking at and comparing 15-year or 30-year mortgages, knowing that in 5 years or so, you'll probably be getting ready to sell the home and move on, the total interest percentage may not be as big of a factor in your decision. This may also not be a huge concern for those who plan to refinance their loans in a few years, rather than just sticking with the rate from origination.
Loans that have varying or adjustable interest rates can be more difficult to compare easily. When looking at loan estimates for adjustable-rate mortgages, it's incredibly important to remember that the total interest percentage is calculated only based on the current market interest rates.
Knowing A Good Total Interest Percentage When You See It
Now that you know how the total interest percentage is calculated and exactly what it means for your mortgage, you will be able to much more effectively compare one lender's offer to another's. This can help you much more easily decide if one offer is better than another, given the time you'll spend in the home and your planned payment schedule. Remember that if you're planning on only being in the home for a few years before you sell, your total interest percentage will still matter; it just shouldn't carry as much weight when you're lender-shopping.
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.