Introduction
Mort is a French word meaning dead. A mortgage is better known as a loan secured by land or property, although sounding like a mortuary and indeed some people might contemplate murdering their mortgage lender. More precisely, a mortgage is actually a legal document, but one amortises a loan, which means paying it off over an agreed schedule and thereby killing it.
In fact, the only distinction between a normal loan and a mortgage, is that mortgage lenders have a house they can legally sell in the event of the borrower not paying as scheduled. Some loans are secured with other assets, such as cars or washing machines, stocks or shares. Some loans are unsecured. But the basic structure and mechanics of the loan is the same whether it is secured or not.
The three essential variables describing any loan or mortgage are: -
1. The initial capital sum or principal that is to be lent.
2. The interest rate which sets the amount of interest to be charged on outstanding capital and when it is charged. The interest rate may vary.
3. A repayment schedule laying out how the interest and capital is to be repaid.
As far as item 3 is concerned, there are an infinite number of repayment variations but the two main types of schedule are: -
(i) Capital repayment loans, where capital is repaid gradually throughout the loan term as part of a regular payment,
(ii)
Interest-only loans, where only interest is paid during the term,
and the amount owing settled at the end with a lump sum.
This sum usually arises from selling a separate asset.
An endowment mortgage aims to use the proceeds of a maturing
endowment policy to repay the debt, but more often it is the sale of a house
that settles the mortgage.
While interest-only loans are very straightforward from the lender’s
viewpoint, their overall value-for-money for the borrower depends totally on the
performance of the separate repayment vehicle.
A loan to a borrower is an investment to the lender. The interest paid by the borrower is an investment return to the lender. So the formulae used to calculate a loan schedule are practically identical to those applying to an investment. Fees and costs will affect the overall return to the investor and will also add to the final burden for the borrower. But fundamentally the mathematics is the same for the borrower and the lender.
Compound interest can be an elusive subject. There is no known simple formula that can be used to calculate true interest rate, given a repayment schedule; so comparing any one “scheme” with any other has never been an easy task. Fortunately, there is an excellent method available and the more prevalent use of spreadsheets has greatly simplified its application. If this book sheds light on this process alone, it may have been all worthwhile.