Help Simple vs Compound

[wader]

Hi there,

Hi guys and gals, sorry for my ignorance but I am having trouble getting my head around this for some reason. Here it goes:



Simple Interest

VTB - 200,000

Rate - 5%

Term - 10years

200k x 5% = 10k

10k x 10yr = 100k

So after 10 years we have the VTB paid back for a total of 300000k



Compound Interest

Conventional - 200,000

Rate - 5%

Amortized - 10yr

2166.30 mthly pmt x 120 = 253956.00



So compounded is a savings of 46044.00



The simple interest should be less than the compound? What am I missing here?



Thanks

Wade

 

[bizaro86]

You're missing the fact that some of the principal is getting paid off in your second scenario, so you don't pay further interest on it.



Example, in year 5 of your VTB example, you pay interest on the whole 200k, but in year 5 of your other example you're paying interest on much less than 200k, because some of the principal has been paid back.



The savings isn't from compound vs simple interest (simple is cheaper for the borrower) the savings is from paying down the mortgage sooner.



Regards,



Michael

 

[wader]

Thanks Michael,



When I show the venor the VTB I wanted to break it down for them. Year one intrest, principal, payment amounts...then year 2 etc. Do I have to go through each year? Or maybe you know an easier way?





Year 1 - 200k @ 5% = 210k

monthly payments = 2k



Year 2 - 186k @ 5% = 195300.00

monthly payments = 2k



Year 3 - 171300 @ 5% = 179865.00

monthly payments 2k



Is the above proper for simple interest?



Thanks again,



Wade

 

[bizaro86]

Are you sure the vendor wants principal payments every year? If I were presenting it, I'd offer to pay interest only for a certain number of years, and then pay off the balance at the end. It makes it easier to calculate, understand and explain (and remember, a confused mind says no) and also improves your cashflow for the first couple of years of ownership.



Regards,



Michael

 

[wader]

I agree this might be another angle, but what im really trying to figure out is the math end of simple interest. Lets say for example



100k VTB

5 year

5%



I want to pay back P&I...what would my monthly payments be?

100k x 5% = 105000

105000 / 60months

= 1750.00



OR



Do I calculate what is left on the principle each year and x that by 5%...and if this is the way that it's done how do i figure out my payments so that it will be paid off in 5yrs, 7yrs, 15yrs, etc.



Thanks

Wade

 

[wader]

Anybody?

 

[staneja]

In your VTB example, you agree with the seller what your monthly payments will be. They will at least cover the interest, and the amount left over that would reduce the principal. Since it's in your interest that you pay interest only on the outstanding principal, create a simple excel spreadsheet that shows fixed monthly payments, calculating interest on outstanding principal every month, and separating out interest and principal portion of the payments for clarity. You will see your interest reducing every month, while the principal payment increases. The outstanding principle will decrease.This is just like in a mortgage, but the interest being calculated is simple interest and not compound interest.

What I find interesting here is that the seller is agreeing on simple interest calculations when the lending industry uses compound interest.

 

[wader]

Great, Thanks for the help everyone.

 

[Pheenix]

[quote user=staneja]What I find interesting here is that the seller is agreeing on simple interest calculations when the lending industry uses compound interest.


By Canadian law institutional lenders are required to "compound semi-annually, not in advance", on fixed rate mortgages, but then in practice do the math to provide the same effective rate, although compounding monthly. Therefore any comparison calculations will actually be more complicated.



The wording and payment terms can then make a difference, 5% simple, payable annually is just that. However, 5% simple annual paid monthly would seem to be 5/12= .004167%. If you then multiple this amount by the principal outstanding on a monthly basis you actually have monthly compounding, as the lender has the (compounding) use of the interest each and very month, giving them an effective rate in excess of 5% simple paid annually.



This is why when the average Canadian tries to calculate what the bank is going to charge on a mortgage it almost never works out. A quoted rate of 5% for a Canadian mortgage, would be aproximately equal to a 5.07% effective rate (when compounded semi-ann.) which works out to be closer to 4.9% (actually 4.9%/12) as an effect monthly compounding rate for payment calculations. Simple eh!



The long and short is that when arranging a VTB that is not based on a Canadian amortization table you should make certain that you stipulate all the terms, and calculation methods, and then illustrate with an example covering a couple months. This is true whether you want to fix the principal, the interest rate or the blended payment for each month.



Just my 2 cents worth (compunded daily of course).

 

[wader]

Im sorry, Im still trying to get my head around this. I always assumed that with simple interest would save me money. Looking at the following example, would it be safe to say that a buyer would be satisfied with paying a little extra (12k in 1st example), so that he can make the property poitive cash flow and then refinance after 5 years?



Example #1

100k VTB @ 5% interest only, for 5 years

monthly payments of $416.67

Total = 125k



Example #2

100k VTB @ 5% amortized, for 5 years

monthly payments $1884.77

Total = 113086.20



Also could either of these be on the title as a caveat instead of a 2nd mortgage as the conventional mortgage companies do not like 2nd's on title?



Thanks for your help everyone



Wade