Simple Interest Mortgages vs. Traditional Interest Mortgages

Simple Interest Mortgages vs. Traditional Interest Mortgages-150x150When 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.

How Much Home Can I Afford?

Your House

Just as a potential home buyer hopes to find a well-suited living space that satisfies their needs and lifestyle, their search for the funding source will be equally matched by a lender’s evaluation of their ability to repay the mortgage. While there are numerous qualifications to be met, the lender is going to focus attention on primary factors, such as credit history, their gross monthly income, and the cash resources available for the down payment. This all translates into what kind of house a borrower is able to afford, and the likelihood of qualifying is determined by the borrower’s ‘debt-to-income ratio’.

The Front-End Ratio

This formula is based on a calculation which encompasses the housing expense, or front-end ratio, combined with the total debt-to-income, or back-end ratio. The front-end portion is determined by how much of a borrower’s gross monthly pre-tax income can be applied to the mortgage payment. As a rule, this includes the principle, interest, real estate taxes and insurance, which must meet a ceiling of 28% of the gross monthly income figure. This can be found by multiplying a borrower’s yearly salary by .28, and dividing that result by 12. As an example, if a home buyer has a salary of $40,000, the equation is: $40,000 x .028 = $11,200, and, $11,200 divided by 12 months = $933.33, the maximum mortgage-related payment per month.

The Back-End Ratio

The back-end ratio is determined by compiling all the debt obligations of the borrower, including the mortgage, auto loans, and credit accounts. When totaled, this figure cannot exceed 36% of a borrower’s gross yearly pre-tax income. The formula would be stated as: gross yearly income x 0.36 / 12 = the maximum allowable debt-to-income ratio. Therefore, the lender’s equation would be: $40,000 (annual income) times 0.36 = $14,400, and $14,400 divided by 12 months = $1200 – the total amount of debt obligations per month. With these figures, a borrower can determine exactly how much house is financially feasible to purchase.

How to Calculate Mortgage Payments

Figuring the right way to calculate your home mortgage is one of the most important components to buying a home.

How to Calculate Mortgage Payments:

There are several parts to a mortgage payment. Not including every detail can cause an unpleasant and extremely mortgage calculatorstressful time for you the home-buyer. You are going to calculate the monthly mortgage payment (principal plus interest) based on the loan amount which is the amount of money you are borrowing. You have to consider the term of the loan, meaning how many years it will take to pay off the loan, as well as the mortgage interest rate you are able to get on the loan. Most mortgage companies and banks have actual MORTGAGE CALCULATORS on their websites for your convenience.

You will need to determine the annual property taxes for your new home. The seller or listing agent can help you with that amount. You will divide this number by 12 to get your monthly taxes on your home.

Homeowner’s insurance is a must. It will not be optional. You will need to get an annual insurance quote from your insurance company. They will need to provide a declarations page to the mortgage company as proof of the insured.

If your loan program requires private mortgage insurance (PMI) you will need to figure that number as well. PMI is required by many lenders on first-time buyers due to the amount of down payment they are able to pay. Your mortgage company will help you understand mortgage refinancing and private mortgage insurance and whether it is applicable to your loan.

For Example:

Loan amount: $150,000
Loan Term: 30 years
Interest Rate: 4.75%

Monthly Mortgage Payment: $782.47

Mortgage Loan Payment $782.47 + Monthly Taxes + Monthly Homeowners Insurance = Total Monthly Payment