A New Type of Mortgage
The borrower’s holy grail of “complete disclosure” regarding loans has almost been attained. A Canadian company is offering a new type of “mortgage” vehicle, that combines your mortgage, car loan, personal loans, and your chequing account into one loan and the interest is calculated on the changing prime rate. This new plan should give the Banks a run for your money.
You start by transferring your mortgage to this Main account as an outstanding balance and the interest clock starts ticking. Interest on your outstanding balance is calculated each day and charged back to you on a monthly basis. Exact simple interest is used to calculate the interest. If no cheques were written on the Main account or deposits were made on the Main account in the first day of this new plan and your transferred mortgage was for $100,000, and the prime rate was 4%, the interest cost for the first day would be;
.04 x (1/365) x $100,000 = $10.96
If no cheques were written on the Main account or deposits were made on the Main account in the first three days of this new plan and your transferred mortgage was for $100,000, and the prime rate was 4%, the interest cost for the first three days would be;
.04 x (3/365) x $100,000 = $32.88
Exact simple interest is calculated each day on the outstanding balance and this interest is kept in a separate column and not added to your outstanding balance. Withdrawals and cheques are naturally added to the outstanding balance as they occur. All deposits to the account immediately reduce the outstanding balance. At the end of the month the column of accumulated exact simple interest is added to the outstanding balance and this shows up as a single line item on the monthly statement.
This is in contrast to the “typical” lending practice of most Banks regarding mortgages. If a mortgage payment is missed on a “typical” mortgage the interest owing is added to the outstanding balance. This is referred to as “deemed reinvestment” (forgive the use of legalese).
Below is the example given in their brochure but analyzed using the MORTGAGE2 PRO software which uses the Deemed Reinvestment method, which is a very close approximation of their separate interest column method. As of January 1, 2001 the Jones family’s opening balance was $104,256.87 The monthly payment MORTGAGE2 PRO spreadsheet had 31 extra days inserted between two monthly payments and was changed to the appropriate interest and all payments were set to zero. A negative prepayment of -$4,256.87 was added to the spreadsheet in order to make the opening balance agree. The debits and credits were handled by inserting the transactions as positive or negative prepayments between the two monthly dates. The days per year was set to 365 and the compounding was set to simple interest so that exact day simple interest could be calculated.
The deemed reinvestment method, from the MORTGAGE2 PRO printout above, shows that on January 31, 2001 the outstanding balance for the month is $101,343.03 and the cumulative interest charged is $627.30
The separate interest column method in their brochure shows the outstanding balance for the month as $101,340.56 which is $2.77 lower, as expected, because the exact daily interest was not added to the outstanding balance each day. Their brochure also shows the exact day accumulated interest to be $624.83 instead of $627.30 which is $2.47 less than the deemed reinvestment as expected. The two numbers are out by 30 cents which is quite common in banking and financial circles due to rounding off by various compilers. The litigious infliction of North Americans coupled with the zeal of some legal minds not versed in mathematics have made most North American lenders reluctant to disclose any type of schedule of payments to the public. I commend this company for their bold efforts in disclosure.
The difference of less than three dollars in interest in the separate interest column method versus the Deemed Reinvestment method, is not the issue! The 30 cent rounding difference is not the issue either!
The SIGNIFICANT POINT is, their new plan allows a borrower complete freedom to pay back a loan faster and without penalty. In essence, their plan is an open mortgage at prime with the ability to make daily mortgage payments. Their monthly statements would be greatly improved by displaying the interest rate each day and the number of days used for each line calculation (as in the negative amortization schedule generated by MORTGAGE2 PRO). Their monthly statement should also show the column of accumulated exact simple interest. People make mistakes, computers make mistakes and calculations need to be verified. Implementation of those improvements on their monthly statement would go a long way in helping them give Banks a run for YOUR money!!!
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For the curious individual that likes numbers, shown below is a screen capture of the program before the 30 extra payments were inserted into the spreadsheet ahead of the yellow line. Also notice the CALCULATOR interest is less because as in all calculators the interest is based upon a 360 day year. The SPREADSHEET interest is greater because the interest each month is based upon a 28, 29, 30 or 31 day month due to the 365 days per year selection in the calculator