Generally speaking, the interest factor denotes a numeral that is applied to work out the interest element of any mortgage payment. In fact, the interest factor is founded on how frequently mortgage payments are made - monthly, semi-monthly, bi-weekly or weekly. Having paid the interest component to the mortgagee, any surplus amount paid by the mortgagor goes towards lessening the principal loan amount. In other words, the money paid in excess of the fixed interest amount is considered as the principal component of that particular payment. The principal component or factor of any mortgage payment lessens the outstanding amount of the loan owed by the mortgagor to the mortgagee. Hence, the interest factor is also the number on which all future mortgage payment computations are rooted.
In order to fully comprehend what has been discussed above, let us study the different interest factors (mentioned in dollars) illustrated below for a mortgage loan of $200,000 taken at a five per cent annual interest:
Now, in order to find out the interest component or element of mortgage payment, it is essential to perform a multiplication applying the suitable interest factor with the outstanding amount owed to the mortgagee. This method is used irrespective of how often the interest is paid. To be precise, the interest component of any mortgage payment may be calculated in the following manner:
For instance, if the outstanding amount or balance sum owed to the mortgagee is $200,000, then the interest component for that particular month's mortgage payment is equivalent to the interest factor for monthly payments (0.004123915) multiplied by the outstanding amount or the balance owed ($200,000). In simple words, it will be represented as under:
While making the actual payment, the interest component will be rounded up to two digits after the decimal and in effect be $824.78. Any amount paid in excess of $824.78 by the mortgagor to the mortgagee that particular month will be considered as the mortgage payment's principal component for that month.
In the event of the mortgage loan being amortized for a period of 25 years, in other words, if the term of the loan is 25 years as per the original mortgage agreement, then the combined monthly payment will be $1,163.21. As discussed above, the interest component of the mortgage of $200,000 is $824.78 in the first month of the loan. Now, if you subtract the interest component ($824.78) from the combined monthly payment ($1,163.21), the remaining sum ($338.43) will be considered as the principal component for that particular month's mortgage payment. In effect, the principal component ($338.43) will go to lessen the principal amount ($200,000) taken as loan and it will stand at $199,661.57 at the end of the first monthly payment of the mortgage. In other words, the mortgagor will now owe a principal sum of $199,661.57 instead of $200,000 to the mortgagee.
When you undertake the process in the second month, you will have to multiply the interest factor with the new reduced balance owing ($199,661.57) to obtain the interest component for that month's mortgage payment. As the interest factor for the mortgage (0.004123915) will remain unchanged, you may obtain the interest component of the second month's mortgage payment by multiplying 0.004123915 (the interest factor) by $199,661.57 (the new reduced outstanding balance) or $823.39. Again, as the blended or combined monthly payment for the mortgage also remains unchanged ($1,163.21), the principal component for the second month's mortgage payment will be $1,163.21 minus $823.39. Hence, the actual principal component of the second month's mortgage payment will be $339.82. When you subtract the new principal component ($339.82) from the outstanding balance at the end of the first month's mortgage payment, your new balance owing will be $199,321.75. Hence, this clearly shows that as you go on making the blended monthly mortgage payments, the outstanding principal balance to the mortgagee continues to be lesser every successive month.
While the above discussions illustrated the case of monthly blended mortgage payments, you may also perform similar calculations for blended mortgage payments made semi-monthly, bi-weekly and weekly. Suppose that the $200,000 mortgage loan was originally an accelerated weekly payment credit amortized for a period of 25 years that will be paid off in only 21.46 years. In this instance, the blended or combined payments made each week will be $290.01. In this event, the interest component in this case is just $189.51. This figure is arrived at by performing a multiplication of the interest factor for payments made every week (0.000947563) by the total mortgage loan amount $200,000 and finally rounding up the results to the first two digits after the decimal. To obtain the principal component of this weekly blended payment you need to follow the same procedure as in the instance of the blended monthly mortgage payments. In this case the weekly blended payment will be worked out at $100.50 ($290.01 minus $189.51). This principal component of the blended weekly mortgage payment will bring down the outstanding loan balance to $199,899.50 at the end of the first week's payment.
While performing the computing it is essential to bear in mind the balance amount owed at the end of each payment, irrespective of whether they are made monthly, semi-monthly, bi-weekly or weekly. Multiply the balance due after the last payment with the suitable interest factor and then divide the result by $1,000 to obtain the interest component of the next mortgage payment. When you subtract the interest component from the blended mortgage payment, you will be able to obtain the principal component on which the blended payment for the following month has to be made. Similarly, in order to obtain the outstanding balance at the end of the second blended payment, you need to subtract the principal component of the second outstanding mortgage balance at the end of the first blended payment. This process is to be continued successively for each blended payment till the mortgage is finally paid off.