When they buy a home, most home buyers take out a traditional mortgage to pay for their purchase. Traditional mortgages are recommended for most borrowers, but you should be aware that there is another, very similar, type of mortgage that may be to your advantage. The simple interest mortgage uses a different method of calculating interest due on your mortgage loan. If this type of mortgage is used correctly, it can help you pay off your mortgage faster.
How is the Interest Calculated?
The interest on a traditional mortgage is calculated monthly. The annual interest rate is divided by 12 and the monthly rate is used to determine the interest on each monthly payment. For example, on a 30 year fixed-rate mortgage with an interest rate of 3.6 percent, the 3.6 is divided by 12. The resulting 0.3 percent is multiplied by the loan balance in order to find out the interest that has to be paid.
The interest on a simple interest mortgage is calculated daily, by dividing the annual interest rate by 365, then multiplying the result with the loan balance. If we use this formula for the example above, the interest on a 30 year fixed-rate mortgage with a 3.6 percent interest rate would be calculated by dividing 3.6 by 365. The result, 0.00986, will be then multiplied by the loan balance in order to calculate the daily interest that must be paid. These daily charges will be then added up every month in order to determine your monthly interest payment.
Which One is Better?
The answer to that question is yes and no, depending on how you plan on using the mortgage. If you make your monthly mortgage payment on its due date each month, without being late or missing a payment, then both simple interest and traditional interest mortgages will cost almost the same. However, if you are late with your monthly payment, the difference between the costs of the two types of mortgages will become much larger.
When making payments on your mortgage, you are typically allowed a “grace period” of 10-15 days after the due date, in which you can still make the payment with no repercussions. Traditional interest mortgages calculate the interest once per month, so you can take full advantage of this grace period. However, being late on a monthly payment when you have a simple interest mortgage means that you will be paying a slightly higher interest for the days that you were late, because the interest is calculated daily. This interest can accumulate over the life of the loan costing you several thousands of dollars.
You can turn having a simple interest mortgage to your advantage by making your monthly mortgage payments before the due date each month. This strategy will result in interest savings, which can also accumulate over the life of a loan, making a simple interest mortgage cheaper than a traditional one.
There is no simple answer when comparing simple interest mortgages to traditional interest mortgages. The best thing to do is research both of them, figure out what your possibilities and future plans are, and find out which one of these two types of mortgages would suit you better.