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The Mortgage Professor: Another look at simple interest mortgages

Jack Guttentag, The Mortgage Professor on

Published in Home and Consumer News

Over the years, I have received a steady flow of inquiries and complaints about simple interest mortgages (SIMs), and have written several articles explaining how they work and how borrowers should deal with them. In doing this, I always viewed SIMs as the product of outdated practices, which in time would disappear. Only recently have I become aware that they are not disappearing, that they are much more common than I had thought, and that the Federal agencies that could make them go away, or at least mandate adequate disclosures, have been looking the other way.

HOW A SIM DIFFERS FROM A STANDARD MORTGAGE

On a standard mortgage, interest is calculated monthly, the monthly payment is due on the first day of the month, and the payment is recorded as paid on that date even when it is delayed. The note stipulates a 10 or 15-day "forbearance" period during which payments received are recorded as paid on the first.

For example, if the loan is closed April 1 for $100,000 at 4 percent for 30 years, the payment is $477.42, and it is due May 1. The interest portion is .04/12x100, 000 = $333.33. The $144.09 difference between the payment amount and the interest charge is deducted from the balance to yield a new balance of $99,855.91. If the payment is not made until later in May, so long as it is received within the forbearance period, the result is the same.

On a SIM, interest is calculated daily and there is no forbearance period. The daily rate is .04/365 = .0001096, so the daily interest charge would be .0001096x100000 = 10.96. On May 1 the interest due would be 10.96 x 30 = $328.80, which is a little less than on the standard mortgage because there are only 30 days in April. With the interest charge a little less, the remaining balance would be a little lower at 100,000 – (477.42 – 328.80) = 99,851.38.

But this assumes that payment is made on May 1. If payment is made later or earlier, the results are different, as shown in the table.

Mortgage of $100,000 at 4 percent For 30 Years, Payment of $477.42 Due May 1

Actual Payment Date Standard Mortgage Simple Interest Mortgage

Interest Charge New Balance Interest Charge New Balance

April 25 $333.33 $99,855.91 $274.00 $99,796.58

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