Paydown factors can also help investors understand the performance of the financial assets they’re investing in, such as mortgage-backed securities.
Alternate definition: The paydown factor looks at how much a borrower is reducing their loan principal. It can be calculated on a monthly basis and may be included in the monthly loan statements from your lender.
For instance, let’s say you recently purchased a home. You want to pay down your principal faster, so you make additional payments toward the principal each month. By paying down the principal, you reduce the amount of interest you have to pay and will pay off the mortgage faster. As you continue to pay more toward the principal each month, your paydown factor will increase over time.
How Does a Paydown Factor Work?
You can use the paydown factor to evaluate consumer loan products like mortgages, auto loans and personal loans. The paydown factor is also an important metric for investors who are 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 look at an example of the paydown factor used on a mortgage. If you want to know the paydown factor for your combined principal payments compared to your original principal, divide what you’ve paid by what you’ve owed. For example, say you took out a $250,000 mortgage with a 3% interest rate over a 30-year repayment term. Your monthly mortgage payments would come to $1,054. For your first monthly payment, you’ll pay $625 in interest and $429 toward the principal of the loan. Your monthly paydown factor is 0.18% ($429 divided by $250,000). You can also calculate your paydown factor based on your total payments. If you’ve paid down $200,000 of your $250,000 principal, your paydown factor would be 80%. Youn can use the paydown factor as a way to chart your payment progress over time. Wathcing the percentage grow as you make payment after payment is a simple way to help you see that your payments are making a dent in your principal.
Mortgage-Backed Securities
Investors use the paydown factor to evaluate mortgage-backed securities. A mortgage-backed security is a collection of mortgages purchased from a bank or lender and bundled together by a government or private entity. From there, investors have the opportunity to earn monthly interest payments on the mortgage-backed security. If you’ve ever considered investing in mortgage-backed securities, looking at the paydown factor can help you evaluate your level of risk. For instance, a paydown factor that steadily decreases over time could indicate that some borrowers are having a hard time making their monthly payments. If you invest in a mortgage-backed security made up of loans issued by private lenders from certain government agencies, Ginnie Mae guarantees timely payments on both principal and interest. For that reason, Ginnie Mae also requires issuers to publish the paydown factor.
