Back 2 Basic: Mortgage

Mortgage loan or home loan is the money which you borrow from bank to buy your house. It is the process transfer of interest in a property as a security to the lender. The word mortgage came from Old French word, which means death pledge. The death is actually referring to the end of pledge when the property obligation is fulfilled or is taken away for foreclosure.

Compared to ‘Hire Purchase’ loan, mortgage or housing loan is easier to understand. But to calculate the monthly payment, it would require a complicated formula. Don’t worry I won’t be touching all lot on it. I’ll teach you on how mortgage works and some simple calculations. Let’s start with an example.

Miss Florina bought a house for $125,000. She paid 10% down payment and took mortgage from bank for the balance, $112,500. The bank charges a fixed interest of 7% per annum calculated on monthly basis. Her tenure is for 30 years.

(Monthly basis is also known as monthly rest)

How to calculate the monthly installment? To calculate the monthly installment we have to use the following formula.


Yup, I know the formula look complicated. Even I didn’t use this formula to calculate. Instead I just used a financial calculator.

By using my financial calculator, the monthly installment computed is $744.13.

Now it’s time to look at how the interest is calculated. Instead of using any complicated mathematical formula, I’ll just show you through simple calculation.


Why we divide by 12? This is because the interest is calculated on monthly basis. A year has 12 months. In reality, majority of the banks’ interest is calculated on daily basis.


As you can see, the interest is calculated based on your balance at the end of 1st month. It’s not fixed interest like hire purchase loan. If you make additional payment, your interest will be calculated based on your mortgage balance. Let’s look at the table below for first 6 month of calculation.


Now let say Miss Florina got 2 months bonus from her company. She decided to pay 6 month installment one shot on the first month it self. Let see what has changed.


The first thing you might have noticed is the balance at the end of 6th month is lower by $66.14.

Let’s have a look, if the interest is calculated yearly basis and she paid 6 month installment one shot.


What did you notice? The first difference is the interest is calculated for the entire year at the beginning, unlike monthly basis where you calculate the interest every month.

Some of you might be wondering on how to calculate the total interest for any year without calculating month by month or day by day for daily basis. There are formulas to calculate them, but unfortunately I don’t have them and it is rather complicated. The easiest way is by using a financial calculator.

That’s all for our 2nd back to basic. Hope all of you learn something from it. Get ready to maximize your mortgage in near future. You will learn how to use your mortgage efficiently and maximize your money management. Coming soon…

Happy Learning. ;)

Back 2 Basic: Hire Purchase Loan

Hire purchase loan is a contract which the buyer become the hirer and the bank or financier financing the goods (example: car) become the owner. You’ll be paying installment to the bank for duration as agreed in the contract, while you’ll have the possession of the car, not the ownership. As soon you have finish paying all installment, the ownership will be transferred to you.

The concept is, you be renting the car from the financier, at the end of the contract you’ll buying back the car at a predetermined price. In reality when you pay your installment it is considered as covering for the rental as well the predetermine price paid by installment.

(Note: Islamic loan use the same method of calculation as hire purchase loan)

How they calculate the interest?

Loan amount × Interest × Number of years = Total Interest

How to calculate the monthly installment?

(Loan amount + Interest) ÷ Number of months = Your monthly installment

Let’s look at an example.

Mr. Ali Babu Cheng (aka Mr. ABC) bought a brand new car for $55,000. He used $5,000 from his savings for the car down payment. He took a hire purchase loan from Iwantyourmoney Bank (aka IWYM Bank) for the balance $50,000. IWYM Bank charge an interest of 5% and the loan tenure is 5 years.

Total Interest = $ 50,000 × 5% × 5 years
= $ 12,500 (Total interest charged)

Monthly Installment = ($ 50,000 + $ 12,500) ÷ 60 months
= $ 1041.67 (The amount Mr. ABC have to fork out every month)


Every month when you make payment, part of the installment will be used to pay interest and another part to settle the principal amount. So, next question my fellow students, what is the amount of interest paid for the 1^st year by Mr. ABC?

Most people might calculate this way,

Total interest ÷ 5 years = Yearly interest charged

So, the interest paid by Mr. ABC for the 1^st year is, $12,500 ÷ 5 = $ 2,500 and interest portion paid per month, $2,500 ÷ 12 = $208.33

That’s what a lot of people think, but the truth is its totally wrong.
Get ready, it’s rather complicated. Here is how it’s calculated,

Step 1:

Add all number from1 until number of 'Total months'. Let's call it sum of months.

Example:
Total months= 60
Add all the numbers from 1 to 60.

60+59+58+57+56+…….+5+4+3+2+1=1830 (Sum of months)

The short cut to calculate this is,

(Total months + 1) × (Total months ÷ 2) = Sum of all number from 1 to 'Total Months'

The same example by using the short cut,
(60+1) × (60 ÷ 2) = 1830 (Sum of months)

Step 2:

((Total month + 1) – N^th month) ÷ 'Sum of months' × Total Interest charged = Interest portion for Nth month.

Example:

For 1^st month of payment, the interest portion is:

((60+1) - 1)÷ 1830) × $12,500
= 60$ 409.836.

For 32^nd month of payment, the interest portion is:

((60+1) - 32) ÷ 1830) × $12,500 = $ 198.09

Step 3:

Now to find the 1st year interest paid by Mr. ABC's on his loan, add interest portion from month 1 to month 12.

(60+59+58+57+56+55+54+53+52+51+50+49) ÷ Sum of months × Total Interest
= Interest for first year.

So,
654 ÷ 1830 × $12,500 = $4,467

That’s 35.7% of your total interest.

As you can see, instead of paying the interest equally, you are paying the most in the first year. Let’s see the percentage of total interest you’ll be paying according to years and tenure for a loan of $50,000 with 5% interest.


What is rebate?

When you have paid fully earlier or would like to settle earlier, you’ll be given a rebate on your interest. Don’t think that you have some discounts on your interest. It’s just a term without any value used to calculate the balance you have to settle. Let me explain in the below example.

Mr. Dhandhum took a hire purchase loan of $50,000 to buy a car. He took it for 5 years with an interest of 5%. He planned to settle the loan within 3 years. At the end of 3rd year, he decided to settle his loan. What would be his total rebate? How much balance he has to pay?

His total loan is $62,500 including interest.
At end of 3rd year, his rebate would be his unpaid interest portion.
So his total rebate = Interest for year 4 and year 5.
= $1,516 + $533
= $2,049

Balance to settle loan = Total loan with interest – Total installment paid – Total rebate
= $62,500 – ($1041.67 × 36 months) - $2,049
= $62,500 – $37,500.12 - $2,049
= $22,980.88

Did you notice something? If you pay your 5 years loan in 3 years, the total interest paid is higher than a 3 year loan.

That’s all for the 1st ‘Back 2 Basic’. I’m sure some of your head already started to spin the moment the math portion came in. But, don’t worry the next ‘Back 2 Basic’ will be much easier than this. Enjoy learning.

Get ready for some mind boggling method to maximize your money. Go to Maximize Your Money: Hire purchase loan. (Coming soon)