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If a lender offers a blended interest rate do I really save money? A simple yes or no cannot answer this question! Usually the lender is offering you a blended interest rate because of one of two reasons. Firstly, you do not want to pay the interest rate differential or the three month interest penalty. Secondly the lender is merging two loans into one thus supposedly making it easier for you with one cheque instead of two cheques. Buyer Beware! The lender is counting upon your novice status as a mathematician. You actually require THREE amortization schedules to answer this question. You need to compare the two separate loans as a "before" and the blended loan as an "after". The same cash outlay and the same time period must be compared before and after. Whether you write out two cheques or one, the balance owing at the end of the same time period must be the same.
What is the difference between a Canadian and an American mortgage? The only difference between a Canadian and an American mortgage is the compounding frequency.American mortgages use monthly compounding and Canadian mortgages use semi-annual compounding. The word "compounding" can be viewed as a mathematical pronoun that helps describe how the interest factor is calculated. The interest factor is the number that is used each month to calculate the interest owing the lender.
For example in the USA a nominal interest rate of 12% has a monthly interest factor of 1% per month (0.12/12=.01). Thus at the end of one month an American borrower owes the lender $1000 in interest for the use of the $100,000 for one month (.01 x 100,000 = 1,000). Any amount of money in excess of the $1000 goes directly towards the reduction of the principal. In Canada the Canadian borrower owes the lender $975.88 in interest after one month because the interest factor (monthly interest factor to be concise) is .0097588. The algebraic formulas, logic and equations are identical. The only difference is when you substitute the different numerical value into the formulas for the interest factor. All the rules of thumb, generalizations and analysis are IDENTICAL for Canadian and American mortgages.
If effective interest rates were used a novice would not have to be concerned about "compounding". For example, a nominal interest rate of 11.7106% with monthly compounding yields an effective interest rate of 12.36% and the monthly interest factor is .0097588
A nominal interest rate of 12% with semi-annual compounding yields an effective interest rate of 12.36% and the monthly interest factor is .0097588 the same as the monthly compounding scenario because the effective interest rates are the same.Another reason for knowing the effective interest rate of your mortgage is that you can compare it to other financial vehicles such as guaranteed investment certificates or mutual funds.
What is the difference between a car loan and a mortgage? In the USA both consumer loans (car loans) and mortgages are blended monthly payments with monthly compounding. Usually, consumer loans have a shorter amortization period of one to five years. In Canada all consumer and car loans are calculated the same as in the USA.
In Canada all residential mortgages must be semi-annual compounding. In Canada lenders offer a variety of payment plans such as weekly, biweekly and bimonthly payments. In Canada and the USA, usually, car loans are blended monthly payment loans with monthly compounding. Some lenders in both countries still use the rule of 78 which is an approximation to an amortization schedule. The approximation will skew the numbers (you pay more of the interest sooner) in favour of the lender, thus buyer beware. One way to be sure that your automobile loan is not done via the rule of 78 is to ask for an amortization schedule BEFORE you drive the car off the lot. Any accountant can easily verify if the schedule is the rule of 78 or a blended payment amortization schedule.
What is an Interest Rate Differential (IRD)? In Canada lenders that charge a prepayment "penalty" for paying off the mortgage early use one of two methods. In Canada they charge a three month interest penalty or an IRD calculation, which ever is greater. An IRD is a method for compensating both the lender and the borrower for a premature ending of a mortgage agreement due to changing interest rates.
The borrower pays the lender a fixed amount of money in order to lower the interest rate for a fixed amount of time. If calculated properly, the lender does not receive any extra interest over the fixed time period and the borrower does not pay any extra interest over that time period. Considering the balance owing on the mortgage the exact amount of money has changed hands due to the IRD payment. Nobody wins or loses.
In general, American borrowers are getting a big break when it comes to prepayment penalties. If an American borrower wanted to prepay a closed mortgage in the first three years a 1-3% charge of the initial loan would be levied. In Canada most likely an IRD would be used. A prepayment penalty on a $150,000 American mortgage would be $4,500 using 3% whereas a Canadian IRD would be about $15,000 based upon a four percentage point differential.
If I pay the IRD to my Lender, will I save money? If the IRD is calculated properly, the answer is No! The only advantage is the mortgage is opened up for renegotiation and if you knew for certain, rates were going to drop even further then it is better to pay the differential now before it becomes even larger.
How much can I save by paying my mortgage weekly instead of monthly? Lots!! The amount of savings depends upon how big the weekly payment is that you select. First of all, by paying weekly even with the same amortization period you will save money. In Canada the lenders usually offer you two weekly payments to choose from; one is based on the same yearly cash flow as the monthly payment but paid back weekly and the second weekly payment plan is based on a yearly cash flow of 13 monthly payments (accelerated weekly). The accelerated weekly saves you more money compared to the non-accelerated. In fact to save the most money make the weekly payment as large as possible within you budget. Paying more frequently and as big a payment as possible saves you interest costs because interest calculations are based upon the outstanding balance owing as of your last payment. Thus minimizing the time between payments and making payments as large as possible is the best and only way to maximize savings on interest!
If I pay weekly payments how much do I save and how long a time period? In Canada, using a $100,000 mortgage, amortized for 25, the accelerated weekly will save you (approximately) the following years and interest costs;
6% 4 years $18,000 (paid off 4 years sooner saving $18,000)
12% 8 years $76,000
18% 11 years $181,000
24% 14 years $308,000
As the interest rate increases the savings become unbelievable!
Will paying monthly and prepaying the anniversary payment every year be the same as paying weekly payments alone? No!! Because you allow a whole year to elapse before any of your prepay money does any good, like reducing the balance.
What is the difference between a consumer loan and a loan for a mortgage? In the USA there is no difference mathematically speaking. In Canada all consumer loans are calculated like US consumer loans and mortgages. However in Canada loans which are used as a mortgage on a home must be calculated using semi-annual compounding.
Do the mathematical rules for mortgages apply to loans as far as saving interest costs? Yes! The fact is that, all the formulas for loans and mortgages are identical except for the value used as the interest factor (due to the different compounding). In fact "a mortgage" is nothing more than a special name for a loan for a mortgaged home.
What does effective interest rate (EIR) mean? Because of compounding and deemed reinvestment, it is the effective interest rate that a lender actually realizes on your one year loan of $10,000 at a 12% Annual Interest Rate with monthly compounding.
The EIR is 12.6825% thus the lender makes a return of 1.126825 x 10,000 = $11,268.25 on the loan of $10,000. If the compounding was annual then the EIR and the Annual Interest Rate (AIR) would be the same.
Will MORTGAGE2 PRO let you change every payment, miss one or more payments, be late with your payments, change the interest rate every month and even include a prepayment along with every payment and still arrive at the CORRECT balance owing to your lender at the end of the year? YES!!!
What is the difference between monthly compounding and semi-annual compounding? The compounding is just a fudge factor used to calculate the interest. For a loan, the more frequent the compounding the more money a lender makes on interest.
For example, a 12% Canadian mortgage using semi-annual compounding is equivalent to an American mortgage at a lower rate of 11.7106 with monthly compounding. In essence a lender using monthly compounding can allow the borrower to pay a lower rate of 11.7106 and still get the same return as a lender that used semi-annual compounding at 12%. The more frequent monthly compounding exactly offsets the lower rate, as can be seen from the two schedules below. Notice that the effective interest rate (EIR in the bottom right corner) is the same for both, which it must be according to the laws of mathematics.
Can MORTGAGE2 PRO calculate the correct balance owing at the end of the year if you made many, many prepayments between regular payments? YES! With the click of the mouse an infinite number of extra prepayments can be inserted between the regular scheduled payments.
What is the difference between a "normal" amortization schedule and one that is sometimes provided by certain Canadian trust companies? In Canada one particular lender uses the "Gale Date method" to calculate interest thus an amortization schedule will never agree exactly with the Gale Date Method as they are different.
What is an amortization schedule? An amortization schedule is nothing more than a financial road map showing you the interest and principal portion of each blended payment and the balance owing after each payment.
Can MORTGAGE2 PRO calculate an exact day interest monthly payment mortgage? Yes! By choosing a "365 day year" the program compensates for a 28, 29, 30 or 31 day and calculates the monthly interest based upon the exact number of days in that monthly period.
Thus the exact day interest schedule (365 days) will have the monthly interest factor change each month. This is in contrast to the "regular" monthly payment schedule (360 day year) that assumes the the year is divided into 12 equal months, thus the monthly interest factor is constant each month.
Your lender advanced you the mortgage money on the 26th of May but wants the monthly payments on the first of each month. July 1st is your first blended monthly payment. The payment of June 1st is an interest adjustment payment and is nothing more than the interest due for the use of the money for 6 days. The interest adjustment date is June 1st.
Can MORTGAGE2 PRO calculate the interest adjustment amount and when it is actually due? Yes. It will actually allow you to use many different ways of calculating the interest adjustment in order to be backward compatible with some lenders. At one time in Canada some lenders actually used exact day simple interest for interest adjustments. Today in Canada most lenders use semi-annual compounding in the interest adjustment calculations.
Can MORTGAGE2 PRO calculate the maximum amount you could borrow for a given interest rate, payment and amortization period? Yes. MORTGAGE2 PRO and MORTGAGE2 PRO PRO allow you to enter any three variables and have the fourth variable automatically calculated.
Could you quickly compare on one screen the monthly payment mortgage with the weekly payment mortgage and see the different interest costs? Yes, using any of the free downloads on the www.amortization.com site.
To calculate the regular weekly payment just type in the other 3 items and change the payment frequency to weekly.
To calculate the accelerated weekly just divide the monthly payment by 4.
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