Question: On the weekend, I visited a bank and spoke to the loans officer about the details of a home loan, the first such loan I have ever applied for (100K! gasp).
I asked all kinds of detailed questions about how repayments work, and was generally satisfied with his answers, except for one. He mentioned that repayments go partially on the principal and partially on the interest, according to the “Rule of 7’s and 8’s”. He was unable (or incapable) of explaining this rule to me, beyond stating that it was `a mathematical equation’. He was also unable to give me any references where I could look it up.
Does anyone here know what it is? Why is there a distinction between repayments being put towards interest or principal? Don’t they both cost you the same amount of interest anyway?
Answer: Paul, there are several shareware & freeware programs available on BBS’s (Compuserve & America Online both have them – you might want to check any others available in Queensland).
The concept of a fully amortizing loan (house loan) is that, of a monthly payment, the interest owed on the outstanding balance is paid first and the rest of the payment is applied towards principal. Principle is the $100, 000 you borrow & pay back. Interest is the cost of doing so.
The small table below shows annual principle & interest payments for a $100, 000 loan, at 7.5% interest, and scheduled to fully amortize over 30 years, paid in monthly installments (but shown annually):
End of Year: Interest Paid Principal Paid Total Paid Balance ———— ————- ————– ———- ——- One $7,468.75 $921.77 $8,390.52 $99,078.23 Two $7,397.19 $993.33 $8,390.52 $98,084.90 Three $7,320.07 $1,070.45 $8,390.52 $97,014.45
The actual equation used for this is complicated – most of use financial calculators, but I am sure you can get in your library at The University of Queensland.
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