The monthly installment of a traditional home loan is computed based on a total reducing principal basis, whereby each of the payment will consist of interest and principal. The interest portion will make up majority of piece in a repayment during the beginning of loan tenure and it will diminish when the time move on and a bigger portion of payment will turn to knock off the principal. This is the concept which we often known as amortization.
While, the idea of 3P of Maybank’s Maxihome special feature is based on the concept of balloon payment (or known as bullet payment). The concept itself is not new in the market. Historically, balloon payment mortgages were first introduced in 1934 in U.S. along with the loan programs by the Federal Housing Administration (FHA) in boosting the ownership of properties. In those day, balloon payment loans were usually to be short termed, ranged from 3 years ~ 5 years and people will convert (or, refinancing) their loan into traditional term loan. The popularity of balloon payment mortgages gained during 1980s and peaked at 1990s when interest rate crept high. The balloon payment option made the monthly repayment lower and more affordable in short term.
Fundamental Mechanism
The monthly installment of a balloon payment mortgage is being segmented into 2 portions, in which:
(i) a portion of the total loan has its monthly installment calculated based on a reducing principal, while:
(ii) the other portion has its monthly installment calculated based on definite and stagnant principal
By the end of the tenure, portion (i) will be reduced to zero balance while portion (ii) will remain the same balance as the beginning of tenure and has to be settled in a lump sum payment.
Visualization and Example
Consider Mr A plans to take up a home loan of RM 500k, tenure 30 yrs, interest is priced at BLR -2.3% (BLR = 6.3%, effective interest rate at 4%).
Traditional Home Loan
Monthly Installment: RM2,387.08
The home loan has its interest calculated based on the previous day outstanding balance. When the outstanding being reduced, the interest due will be reduced in proportion as well.
1st Month: Out of RM2,387, RM 1,666.67 is the interest due based on the outstanding amount of 500k while the remaining RM 720.41 will be used to knock off the principal.
Note: 500k X 4% X 30/360 days = 1666.67
Balloon Payment Mortgage:
Consider Mr A decided he is going to settle 50% of his total loan in a lump sum by the end of the tenure, thus loan amount will be:
Portion (i): 250k
Portion (ii): 250k
Total: 500k
The monthly repayment calculated based on balloon payment is RM 2,026.87, which is RM 360.21 lower than standard monthly installment
How does it work? Portion (i) will have its monthly installment calculated based on amortization method:
Thus, portion (i) will have a monthly installment of RM 1,193.54.
1st month: Monthly installment consists of RM833.33 interest due and RM 360.21 to knock off the principal.
Note: 250k x 4% x 30/360 Days = 833.33
While portion (ii) will have a definite non-reducing principal loan of 250k. Each of the months, only interest will be served. Interest due for each month:
250k x 4% x 30/360 Days = 833.33
Thus your total monthly payment is 1,193.54+833.33 = 2,026.87
It is clear that every payment will only serve interest incurred in portions (i) & (ii) and principal of portion (i) while principal in portion(ii) will not be served.
Outcome:
1. Month repayment of a balloon payment mortgage will be lower than traditional mortgage.
Based on rule of thumb, repayment will be lower by:
15% - if portion (ii) is 50% of total loan amount
12% - if portion (ii) is 40% of total loan amount
9% - if portion (ii) is 30% of total loan amount
6% - if portion (ii) is 20% of total loan amount
3% - if portion (ii) is 10% of total loan amount
2. Interest cost will be higher with balloon payment mortgage, (if no refinancing and no additional payment)
Based on rule of thumb, total interest cost will be higher by:
30% - if portion (ii) is 50% of total loan amount
24% - if portion (ii) is 40% of total loan amount
18% - if portion (ii) is 30% of total loan amount
12% - if portion (ii) is 20% of total loan amount
6% - if portion (ii) is 10% of total loan amount
Usage:
Balloon payment is used to be a short term arrangement as it lowers the monthly installment at the cost of increasing interest cost throughout the tenure. Normally, investors and those homebuyers who look for better cash flow position in short term will look for this option.
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