Monday, December 9, 2013

A brain fart on a long term mortgage calculation.



Today I was planning a post on long-term (60 year )mortgages.   Was crunching numbers in my Numbers spread sheet but could not post because the numbers did not make sense.  I doubled and tripled check.  Went into Excel and got the same answer.

I need advice on what I am doing wrong.  Here is the situation.

I was calculating mortgage payments on 60-year mortgages.  Two calculations are presented below.


Rate annual
0.04
0.20
Monthly
0.00333333333333333
0.01666666667
Number of months
720
720
Loan Balance
$300000
$300000
Future loan Balance
$0
$0
Pay End  of Period Option=0
0
0
Payment
-$1,100.21
-$5,000.03
Interest Estimate
$1000
$5000.00
Payment-Interest Estimate
-$100.21
-$0.03

The first column has the payment on a $300,000 sixty-year loan at an annual interest rate of 4.0%.  Payment is credited at the end of the month.   The monthly payment is $1,100.21. 

The interest estimate is $1,000.  (0.04/12 x $300,000). Under a zero-interest loan, the mortgage balance should stay at $300,000; hence interest only payments should be the monthly interest rate times the initial balance.   

The difference between mortgage payment and interest estimate is $100.21.

The second column has the payment on a $300,000 sixty-year loan at an annual interest rate of 20.0% Again, payment is credited at the end of the month.    The mortgage payment and estimated interest rare both basically $5,000.  

Why is the differential between payment and estimated interest so small at larger interest rates?

I would expect that for long-term mortgages the total payment would converge to interest payments.   Also, at higher interest rates interest dominates. 

Still why would all non interest payments disappear at higher interest rates when mortgage term is 60 years?

Anyway, it is my understanding that the CFPB is getting rid of interest-only mortgages.   Probably long over due.   But won't this move just result in banks issuing longer maturity loans especially when interest rates rise?????

Hope one of my readers can point me in the correct direction on this calculation.  











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