Repayment Mortgage
Traditional mortgage loan is a repayment mortgage loan. Characteristic of traditional mortgage repayments is that the loan is completely repaid or amortized at the end of the loan term. For achieving this, the lender uses mortgage repayment formula. This formula helps the lender in ascertaining an EMI or the equated monthly installment. The variables used in mortgage repayment calculation are the principle, rate of interest, and the term of repayment.
Any such EMI therefore includes interest proportionate to the period, and some principle component that ensures that the monthly installment remains uniform or equated. Interest is calculated on outstanding principle. Since some part of loan, however small, is being repaid through EMIs every month, the interest component within the overall EMI keeps on decreasing. This gap created by the decreasing interest component is filled by an increase in principle component, thereby keeping the monthly installment a constant.
But that is standard way of repaying or amortizing a mortgage. There are several variations of this form of mortgage repayments. For example, the borrower may be asked to pay only the interest component for the entire term, and at the end of the term, the borrower may be asked to pay the entire principle. Similarly, in another type of mortgage repayment, the borrower might be offered a moratorium of a couple of years during which, the EMI may only consist of interest component. The actual amortization of the mortgage loan would start at the end of this moratorium. Therefore, EMI increases substantially in such types of mortgage repayments but remains constant thereafter.
Another factor that affects the mortgage repayments is the way the interest is calculated on the mortgage loan. Generally, lenders calculate interest on mortgages at fixed rates or at variable rates. Fixed rate interest implies that the interest on the loan will be calculated at a fixed rate throughout the term. Unlike it, the variable rate of interest implies that the interest on the loan may vary. Even when interest rate varies under variable rate or adjustable rate mortgages, the EMI may remain constant. Any result of such fluctuation in interest rates is adjusted towards the end of the loan term, either by collecting a lump sum, or by extending the term of repayment. The borrower may, however, choose to increase the EMI such that the term is not extended beyond the period that has been agreed to initially.
Mortgage repayments make the borrower eligible to some tax relief. The interest that is paid on mortgage during the year can be set off against the income of the year. This results in lowering of income tax. If the borrower opts for mortgages like the endowment mortgages, then he or she may also be able to claim tax relief for the life assurance premium that is paid towards the endowment policy that forms part of such mortgages.
Mortgage loans offer a mutually beneficial way to both lenders and the borrowers. The lenders are able to find a reliable customer, and plan their funds. In addition, the loans they offer are secured against real estate properties, which, if not today, may always have some equity built in it, such that it covers the dues if any to the lenders. Apart from this, lenders get interest at a much higher rate than the interest they pay to people who deposit monies with them. Effectively, they make optimal use of funds available with them, earning profits in the process. From borrowers perspective, mortgage loans and mortgage repayment schedules enable them to purchase a home or other real estate property. Since mortgage repayments are almost constant, and they are spread over long period, the value of the monies that leave borrowers' pockets is considerably lower than the value of the property that the borrowers are left with. This discounting effect is due to inflation.