What would happen if you attempted to sell the house and pay off the mortgage before its maturity? You would have paid off more principle and less interest, but the payoff due would come out the same as under the conventional amortization scheme. The reason is that the interest portion of each payment is proportional to the remaining balance at that point in time. In other words, the interest is calculated on the balance outstanding -- capital borrowed. While the scheme may seem to favor the bank by lengthening the payout, it is rational when considered in terms of the capital employed -- the amount that the lender has actually provided and the borrower used -- which changes as the principle is paid down. (While the relations are symmetric between borrowers and depositors, I believe we can disregard the latter in this analysis.)
So, in the example of a $10,000 mortgage bearing 5% interest and, for simplicity, annual payments paid in arrears (i.e., at the end of the year), the first payment would include $500 in interest and a smaller amount of principle, lets say $100, making a total payment of $600. Then, at the end of the next year -- with a balance outstanding of $9,900, the amount of the $600 payment going to interest would be $495 ($9,900 X .05), and $105 to principle. And this progression continues such that the final payment is almost all principle because the principle, and thereby the interest portion, has been reduced to almost zero. What I am describing is called "simple interest" and it is enshrined in banking laws designed to make the stated rate comport with the reality of a calculation that is rational and fair to both borrower and lender (unlike older, discredited amortization schemes such as the rule of 78ths). Peter Hollings -----Original Message----- From: PEN-L list [mailto:[EMAIL PROTECTED] On Behalf Of Daniel Davies Sent: Thursday, March 17, 2005 3:39 PM To: PEN-L@SUS.CSUCHICO.EDU Subject: Re: [PEN-L] People vs Banks You have basically got it; all your points are right, but look at it from the point of view of the depositors. Pretend you've got a $100,000 savings account and you're living off the interest (this is an unrealistic example but bear with me). If that rate of interest is 5%, then you're living off $5k/year. If the bank hands you back 5% of your money ($5,000), then in order to maintain your income, then you've got to find somewhere to invest that money at 5%. If interest rates have fallen during the meantime, so that new deposits are being taken at lower interest rates, you're in trouble. Obviously, there will be some people who are prepared to take this risk and inconvenience in return for a slightly higher deposit rate. But in order to finance an entire mortgage bank like this, I suspect it would be expensive. I suspect that mortgages like this have been designed (Doug will know) but I think they weren't cheap. best, dd ^^^^ CB: Thanks for the response, dd. Let me try to follow what you say. The depositors are lenders to the bank ? They lend at a certain rate of interest ? Wouldn't it be true that if a greater proportion is attributed to principle of the monthly payment to the bank from the mortgagor, and a greater proportion of the banks' payments to the depositors is proportioned to principle over interest, then the depositors would be paid off faster and the term that interest would be paid out would be shorter and the total amount of interest due the depositors would be less ? In other words, isn't the same thing true of the depositors in relation to the bank , as the bank in relation to the depositor ?
