By tradition, mortgages payments were made every month. However, in the recent times the frequency of mortgage payments have changed as the mortgagees now accept mortgage payments every week, every two weeks and even twice a month. This change has also been well accepted by the borrowers or people purchasing new homes. All said and done, the frequency of mortgage payment is one aspect, while the regularity of computing the interest on mortgages is another.
It may be noted here that when the mortgage loan is computed or compounded more often with the other aspects of the contract remaining identical the mortgage becomes dearer for the borrowers, but profitable for the lenders. Hence, irrespective of whether they are seeking a mortgage credit, car loan or even a credit card it is important for all borrowers to learn how the interest on that particular credit is being calculated. Usually, the investors prefer loans for which the interest computing as well as the payment frequency corresponds. It may be done either monthly or bi-monthly. To be precise, most credits worth relatively smaller amount such as car loans or personal loans are planned in this manner. It is very simple to find out the monthly interest payments when the interest is computed every month. All you require to do in this case is to divide the total interest rate by 12 to determine the amount charged each month. For instance, if the yearly interest rate is eight per cent, the interest rate payable every month will be around .66666 per cent. However, when .66666 is multiplied 12 times annually, the effective interest rate per annum stands higher at 8.16 per cent. It may be mentioned here that the 'effective interest rate' denotes the actual interest charges received by the lender every year.
In effect, it is not only very simple to calculate the interest rates every month, but also easier to understand when the borrower is making a combined monthly payment. However, this system eventually proves to be costlier for the borrowers. Since the interest on mortgages are calculated on a monthly basis in the United States, the mortgage amortization books as well as the schedules applicable in that country are not feasible in the normal Canadian mortgage business where the mortgage interests are computed twice a year.
Many people often want to know the differences and benefits of calculating interest rates every month and twice a year. Here is a simple explanation. When the annual interest rate on a mortgage is eight per cent, it works out to four per cent when calculated in the semi-annual or twice a year system. Hence, it is simple to work out the interest rates when payments are made just twice a year or once in six months. However, the interest rates are normally computed more frequently - every month, every week and sometimes even twice a month. Therefore, in the instance when the mortgage interest is computed semi-annually or once in six months, but paid every month, it requires a monthly 'interest factor' as when the interest payable each month is compounded six times over, the result is four per cent after the six month period. In this case, it is essential for the monthly 'interest factor' to be lower than .66666 per cent for this is exactly the interest rate for each month when the annual interest rate is eight per cent when the interest is determined every month and not once in six months. When you calculate eight per cent mortgage interest semi-annually, the exact monthly interest factor will be .655820 per cent, which is slightly lower than eight per cent annual interest calculated monthly.
When payments are made each week for eight per cent interest rate per annum calculated semi-annually, mortgage interest factor will be equivalent to the eight per cent annual interest rate computed semi-annually, but paid every month. To be precise, the weekly interest factor of a mortgage is equivalent to a figure which when compounded 26 times will yield four per cent semi-annually. In this case, the exact weekly interest factor will stand at .150549 per cent.
Calculating the precise interest factors manually is not only a difficult task, but almost impossible. However, when you use efficient computerized mortgage packages, you will be able to do these calculations in a few moments and they will be accurate to the 10 decimal points or even further.
The table below illustrates the disparity between the mortgage interest computed every month and once in six months. It also depicts the savings made by the borrower on amortizing a mortgage for specific terms. For easy calculations, the mortgage loan is assumed to be $100,000 that has pay back period of 25 years.
|Total interest cost
|Saved over amortized life of loan:
The figures presented in the table above may be interpreted in a different way too. In this case you need to evaluate the different amounts the borrower had to pay annually as interest on the mortgage by calculating the interest rates differently - on a monthly basis as well as semi-annually.
First, you will find that if you compute an annual interest of eight per cent once in six months or semi-annually, the borrower will end up paying 8.1345 per cent every year, while if the same interest rate is calculated every month, the debtor will end up paying a higher sum at 8.30 per cent. Similarly, you will also notice that a yearly interest rate calculated semi-annually is equal to 8.16 per cent, but when it is computed annually it is simply eight per cent.
Normally, when a home owner acquires a second mortgages or an individual obtains a credit from any financial institution or credit society, he or she is required to pay interests that are computed on a monthly basis. Lawfully, even people acquiring first mortgages may also be asked to pay the interest on a monthly basis. Moreover, even when the borrower is paying the interest calculated semi-annually, it is not necessary to mention this aspect in the mortgage agreement.
All these have led to widespread confusion among the people and hence such perplexity needs to be removed. In fact, there is a need for a regular benchmark for the Canadians to enable them to calculate the exact price they are paying for their credits and also help them to compare the amount they are shelling out for different types of mortgages annually. If this is not done, there will only be more disorientation if the lenders quote the same credit interest rate, but calculate it differently. Many experts are of the opinion that Canada requires an Effective Annual Interest Rate method that would encompass all kinds of credits - car, business, personal and even mortgage. Implementation of such a uniform interest rate would enable one to know the interest charges being paid by borrower and what is being earned by the lender every year. The proposed interest rate would be computed on a yearly basis and would be independent on how frequently the credit payments are made.
Do you know the meaning of the term 'not in advance' in the mortgage business? If not, please know that the term generally denotes calculating the interest on a credit as well as paying it at the beginning of the mortgage period. In fact, this is also a major difference in the mortgage approaches followed in America and Canada. While the interest is computed and paid at the start of the mortgage term in the United States, in Canada it is paid at the end of the term. This aspect provides an important advantage to the borrowers in Canada.
In order to make the term 'not in advance' easily comprehensible just take the instance of a tenant. Suppose the tenant pays his or her rent on the first of every month for the ensuing month, in effect they are making an advance payment. This, in fact, is a great advantage for the landlord who is able to use the amount for the whole month. Contrarily, a mortgagor or owner of a home does not pay the interest on the credit in advance or on the first of the month for which the interest is meant for, but on the first of the following month. For instance, if the interest payment is for the month of January, the home owner will not pay it on January 1, but February 1. Hence, the interest payment is not made before time, but after it is due. In this case, the borrowers and not the lenders are in an advantageous situation and are able to use the money for the entire month. Although the borrowers are not required to pay the interest on their mortgages in advance, it is advisable to check the facts before signing the mortgage agreement.