Philadelphia Weekly

REAL ESTATE

Put mortgage to 'time horizon cost' test

Part 4: Changing the way people buy mortgages

By Inman News Feed

Add Comment | Comments: 0 | Posted Feb. 7, 2011

The cost measure used will be some variant of what I call "time horizon cost," or THC. The THC is the total cost of the mortgage in dollars over the period the borrower expects to be in the house. It makes more intuitive sense to borrowers than the APR and is easier to understand. It is comprehensive in its coverage.

And it takes account of differences between borrowers in time horizon, tax rates and opportunity costs. It can also be measured on ARMs using alternative assumptions about future interest rates, including "worst case," which gives borrowers a sense of whether they can tolerate the risk.

The THC can also be broken down into its components for borrowers seeking a deeper understanding of the bottom-line results. This enhances its credibility and encourages its use. The APR, in contrast, cannot be decomposed into understandable components, which is another reason it is not used.

Decision supports are for borrowers who need them and have the capacity to use them, which does not cover all network users. The network should also accommodate borrowers who don't need support because they already know exactly what they want, and at the other extreme, borrowers who need help but can't manage online supports on their own. This suggests a need for multiple channels, which is the topic of next week's article.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.