Question:

What is the difference between mortgage payment rate and monthly payment rate?

Answer:

Mortgage Payment Rate:

Mortgage payment rate is simply the interest rate over the period of the loan that is used to calculate the amount of interest the borrower owes the lender. It is commonly expressed as a yearly percentage rate but it should be noted that interest on mortgages is compounded monthly. So, essentially, the actual interest rate over a mortgage loan is a monthly rate.

Monthly Payment Rate:

Monthly payment rate is the rate through which monthly payments from the borrower to lender are calculated. Usually the monthly mortgage rate is the same as the monthly payment rate but some mortgage options allow borrowers to make lesser payment rates initially and larger payments later. In these options the mortgage payment rate and the monthly payment rate are different.

Example of Different Mortgage Payment Rate and Monthly Payment Rate:

If lenders want to offer a mortgage with low initial payments then they will calculate the monthly payments at a rate lower than the interest rate. Let us assume it to be 5% as an example and the interest rate to be 8% on a loan of $200,000 to be paid in 30 years (or 360 months).

Using annuity formula**, the monthly payment at 5% is $1074, but since the payment rate is below the interest rate; the monthly payment is, to say plainly, not eating into the balance (The technical term is amortizing).

The borrower is now required to pay $1074 but because the interest rate is 8%, the interest due the lender is 200,000*0.08/12 = $1333, the shortfall of $259 must be added to the original loan balance. The shortfall is called "negative amortization" and it adds up to the original loan after every payment.

Therefore, at some point in the future, the payment must be recalculated at the interest rate to be fully amortizing over the remaining life of the original loan plus the negative amortization.

**The annuity formula is as follows:

M = P [ i(1 + i)n ] / [ (1 + i)n - 1],
M being the monthly payment

Where, P is the Principal amount;
n is the number of compounding periods (in this case number of months);
I is the Monthly interest rate.

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