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Thursday, February 12, 2015

Total Interest Percentage or "TIP"

QUESTION
Recently, I learned that the new TILA/RESPA disclosure is going to have a disclosure term, called TIP. We already have the APR, why now do we need yet another interest rate disclosure? What is this TIP and how is it calculated?

ANSWER
Section 1419 of the Dodd-Frank Act amended TILA to add the new section 128(a)(19), which requires that, in the case of a residential mortgage loan, the creditor must disclose the total amount of interest that the consumer will pay over the life of the loan as a percentage of the principal of the loan. [15 USC 1638(a)(19)] TILA section 128(a)(19) also requires that the amount be computed based on the assumption that the consumer makes each monthly payment in full and on time, and does not make any overpayments.

This calculation is the “Total Interest Payment,” or “TIP.” Briefly put, TIP is the total amount of interest that a consumer will pay over the loan term as a percentage of the loan amount.

The Bureau commissioned a report on the concept, known as the Kleimann Testing Report. This report concluded that participants used the TIP as a measure of what they would pay in interest in the Closing Disclosure. Further, it showed that participants expressed surprise at how much they would pay in interest on their mortgage loans and seemed to appreciate the disclosure for this reason.

The TIP concept is controversial. There were numerous comments about it before it became the law of the land. Among other things, some loan originators believe that TIP information is completely unnecessary and will prove very confusing for consumers. They assert that the interest rate and the annual percentage rate (APR) are already required to be disclosed on these forms. Adding a third rate, the TIP, would be very confusing and consumers will simply not understand that this rate is unrelated to the interest rate and APR, which is essentially the costs over the long term expressed as a rate. [§ 1026.37(l)(3) and comments 37(l)(3)-1 as proposed]

There are mortgage industry members who think that the TIP will only serve to alarm consumers when they see how high the TIP is, especially if consumers believe there is some connection to the other rates listed. In other words, these consumers would simply not understand the reason this rate is high, how it is calculated, or whether they may choose the type of loan to apply for based on the fact that the TIP may be lower - even though another type of loan may be more appropriate. 

Importantly, residential mortgage lenders and originators themselves are unsure about how the TIP rate is calculated if (1) the interest rate can change over the life of the loan and (2) the future rates are not known at the time of application. Nevertheless, the Bureau held that the total interest percentage is a useful tool for consumers.

Calculating the TIP requires a set of algorithms that utilize the assumptions set forth in the requirement to disclose the total interest percentage on the Loan Estimate, found in § 1026.37(l)(3) and its commentary.

The Bureau also provides guidance to creditors on calculating the TIP for adjustable rate mortgage loans. In particular, when creditors use an initial interest rate that is not calculated using the index or formula for later rate adjustments, the disclosure should reflect a composite annual percentage rate based on the initial rate for as long as it is charged and, for the remainder of the term, the rate that would have been applied using the index or formula at the time of consummation. [§ 1026.37(a)(10)(i)(A), § 1026.37(l)(3); comment 17(c)(1)-10] For Step Rate loan products, the creditor computes the TIP in accordance with § 1026.17(c)(1) and its associated commentary. [§ 1026.37(a)(10)(i)(B), § 1026.37(l)(3)]

For negative amortization loans, the creditor computes the TIP using the scheduled payment, even if it is a negatively amortizing payment amount, until the consumer must begin making fully amortizing payments under the terms of the legal obligation. [§ 1026.37(a)(10)(ii)(A), § 1026.37(l)(3)]

Jonathan Foxx
President & Managing Director
Lenders Compliance Group