The paydown factor is the percentage of the principal amount of the loan that you are paying down through your monthly loan payment.
Definition of Paydown Factor and Examples
The paydown factor is the percentage of the total principal that is repaid monthly. You can calculate your paydown factor to analyze the percentage of principal that you are repaying each month. The paydown factor can also help investors understand the performance of the financial assets they are investing in, such as mortgage-backed securities.
How does the Paydown Factor Work?
You can use the paydown factor to evaluate consumer loan products such as mortgages, auto loans, and personal loans. The paydown factor is also an important metric for investors interested in mortgage-backed securities. In both cases, the paydown factor is a simple way to understand the relationship between the current principal and the original principal.
Mortgages
Let’s take a look at an example of the paydown factor used in mortgages. If you want to know the paydown factor for cumulative principal payments compared to your original principal, divide the amount you have paid by what you owe. For example, assume you borrowed $250,000 on a mortgage with a 3% interest rate over a 30-year repayment period. Your monthly mortgage payments would amount to $1,054. For the first monthly payment, you would pay $625 in interest and $429 in loan principal. Your monthly paydown factor would be 0.18% ($429 divided by $250,000).
You can also calculate your paydown factor based on total payments. If you have repaid $200,000 of the original principal of $250,000, your paydown factor would be 80%.
You can use the paydown factor as a way to track your payment progress over time. Watching the percentage increase with each payment is a simple way to help you see that your payments are reducing the original principal.
Mortgage-Backed Securities
Investors use the paydown factor to evaluate mortgage-backed securities. Mortgage-backed securities are a pool of mortgages that have been purchased from a bank or lender and packaged by a government or private entity. From here, investors get the opportunity to earn monthly interest payments on mortgage-backed securities.
Most mortgage-backed securities are issued by Ginnie Mae, Fannie Mae, or Freddie Mac.
If you have considered investing in mortgage-backed securities, looking at the paydown factor can help you assess your level of risk. For example, a paydown factor that consistently decreases over time may indicate that some borrowers are having difficulty making their monthly payments.
If you invest in a mortgage-backed security made up of loans issued by private lenders from some government agencies, Ginnie Mae guarantees timely payments on both principal and interest. For this reason, Ginnie Mae also requires issuers to publish the paydown factor.
Source: https://www.thebalancemoney.com/what-is-a-paydown-factor-5197101
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