A method of loan repayment where
periodic amounts of principal and interest
are applied in a way that the payments
remain constant in amount, although the
portions attributed to principal and
interest vary with each payment. This type
of plan is sometimes referred to,
erroneously, as an amortized payment plan .
In reality, any payment plan through which
principal amounts are spread over time to
liquidation, regardless if the payments are
equal or not, is an amortized payment plan.
A true blended payment plan exists if,
during the term of the mortgage, equal
payments are made at regular intervals, and
each payment is a blend of principal and
interest.
Blended payment plans have proven most
popular with residential mortgage loans over
the last several decades due undoubtedly to
the fact that payments remain constant
during the term of the loan and allow for
better budgeting. Although any payment
period can be agreed to by mortgagee and
mortgagor, today’s residential mortgage
usually consists of monthly payments
(although weekly, bi-weekly, and
semi-monthly options are becoming more
popular in a competitive mortgage market).
If a Canadian mortgage consisted of
compound interest on a monthly basis (e.g.,
8% per annum compounded monthly), the
calculation of a blended payment would be a
simple matter. Difficulty arises, however,
since the Interest Act imposes a special
restriction regarding disclosure of interest
in blended payment plans.
This Act applies only where principal
and interest payments are blended. The
reasoning is, since the interest amount is
hidden in the blended payment, the borrower
has no way of knowing just how much
interest, or at what rate, the loan is being
repaid.
The Interest Act does not attempt to
control the rate of interest to be charged,
it merely requires the effective rate of
interest be quoted as: calculated annually,
not in advance; or calculated semi-annually,
not in advance.
The word calculated as used in the Act
is synonymous with compounded. The more
frequently interest is compounded, the
greater the amount of interest charged.
Obviously, the lender will select the
calculation that produces the greatest
return. In fact, interest is quoted as
calculated semi-annually, not in advance in
most blended payment mortgages in Canada.
Lenders address the problem of compounding
every six months, when the mortgage calls
for monthly payments. Effectively, the
lender builds in a rebate to the borrower to
compensate for this factor. Advanced
calculators and computer software programs
easily handle mathematical complexities
relating to Canadian blended payment
mortgages.
Example of Blended Payment
Borrower Reed arranges a mortgage for
$10,000 at an interest rate of 12% per annum
with blended monthly payments. Interest must
be calculated annually or semi-annually not
in advance. As a result, lenders have
established slightly reduced monthly
interest factors to ensure that the
compounding does not exceed Interest Act
requirements.
The monthly interest factor used is
.00975894. (Detailed tables are not
provided.) By multiplying the factor by the
principal owing during any period, the
actual interest charged can be calculated.
While this factor produces a true effective
rate greater than 12% per annum (allowing
for compounding), the result falls within
federal guidelines.
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