The Truth in Lending legislation in the USA in some instances could be appropriately called the Truth in Lying legislation, because it does not properly address some mortgage issues! The following example will illustrate the point.
If you borrowed $100,000 at an annual interest rate of 6% with monthly compounding for 30 years the monthly payments would be $599.55 The effective interest rate (EIR), because of monthly compounding, would be 6.1677812%. The EIR shows the lender how much money he makes each year by reinvesting each monthly payment, at the same interest rate, as it is received.
If you borrowed $10,000 at 12% for two years, how much would the lender make at the end of two years? The EIR is 12.6825%, after one year the lender makes;
10,000 x 1.126825 = $11,268.25
and after two years the lender makes
$11,268.25 x 1.126825 = $12,697.34 which is within a penny of the negative amortization schedule below. The balance at the start of each year multiplied by 1+EIR/100 shows the lender what the investment is worth at the end of the year.
You can now appreciate the significance of the EIR, lets get back to the initial $100,000 mortgage example.
Just to reiterate, the example screen below shows the EIR via the Present Value Future Value window, the negative amortization schedule in the SPREADSHEET and the CALCULATOR, .. all agree with an EIR of 6.16778%
The total interest paid (Cumulative) by the borrower to the lender is $502,257.68 over the 30 years.
QUESTION: If your lender used a 365 day year, exact day, monthly payment schedule, would you know that the EIR was greater compared to the "Bankers Year" schedule which is based upon a 360 day year???
If you had an amortization schedule you would know that you paid your lender an EXTRA $790.39 in interest over the 30 years. The EIR for a 365 day year schedule will not show up on any Financial Calculator. By changing the days per year to 365, then doing a negative amortization schedule in the SPREADSHEET, then using the accumulated value of $603,048.07 to plug into the Present Value Future Value window you can determine that the actual EIR is 6.172424% not 6.167781 as any standard financial calculator would show.
Generally one converts Canadian per capita information to American per capita information by multiplying by a factor of 10 as the USA has approximately ten times the population. If the USA residential mortgage market is approximately tens times the Canadian market then there is 4 trillion dollars lent out each year in the USA for residential mortgages.
6.1724% - 6.1678% = .0046%
.000046 x 4,000,000,000,000 = 184,000,000
American homeowners/borrowers could be paying as much as an extra 184 million dollars in interest each year and and not be aware!!!
That is a tremendous price to pay for not knowing the facts!!
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