The basic disadvantage of a simple interest mortgage lies in the fact that unless the borrower conscientiously makes all of his mortgage payments on time, he could end up paying substantially more in interest than he would if he had a standard mortgage. However, the one potential advantage of a simple interest mortgage is that if the borrower regularly makes his payments early, he can actually end up paying less in interest than he would have if he had a standard mortgage.

The difference between a simple interest mortgage and a standard mortgage is a difference in the manner the interest on the loan is calculated. Both are simple interest accrual loans. Simple interest mortgage in this context does not mean that the mortgage features simple interest while a standard mortgage has compound interest. It is merely a term used to distinguish the two types of mortgage loans. The interest on a simple interest mortgage is calculated daily, in contrast to a standard mortgage loan on which the interest is calculated monthly. The interest calculation for a simple interest mortgage is done by dividing the interest rate by 365 and then multiplying that figure by the outstanding principal balance. With a standard mortgage, the interest rate on the loan is divided by 12 to get the monthly interest rate, and then the outstanding principal loan balance at the end of the preceding month is multiplied by that monthly rate to calculate the amount of interest due for the current month.

The amount of interest paid on a simple interest mortgage, assuming that all monthly mortgage payments are paid on time, is still slightly higher than the amount that is due on a standard mortgage, because the total number of days figured into the calculation is greater. For example, assuming a $100,000, 30-year mortgage at 6%, an individual who has been making all of his payments on time with a simple interest mortgage pays approximately $400 more in interest than would be the case with a standard mortgage. The difference in total interest payments, and therefore the disadvantage of a simple interest mortgage, is amplified by higher interest rates.

If the simple interest mortgage borrower regularly makes payments 10 days early, he realizes significant savings in total interest payments compared to having a standard mortgage. Conversely, if he is regularly 10 days late making monthly payments, he pays a significant penalty in additional interest.

Borrowers who regularly make extra payments to principal still fare better with a standard mortgage over a simple interest one, because most mortgage lenders credit any extra payments made in the first 20 days of the month to the preceding month's principal balance.

  1. What are the different types of subprime mortgages?

    Clarify your understanding of subprime mortgages. Learn about the different types, how they work and when they might be beneficial. Read Answer >>
  2. When Do Mortgage Payments Usually Start?

    Discover when your first mortgage payment is due and how it differs from rent. Learn about the closing process and why you ... Read Answer >>
Related Articles
  1. Personal Finance

    Understanding the Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  2. Personal Finance

    Finding the Best Mortgage Rates in 2017

    As home-buying technology has progressed, the process of finding the best mortgages rates can all be done online. Here's how:
  3. Personal Finance

    Shopping for a Mortgage in 2017? Use This Tool First

    As home-buying technology has progressed, the process of finding the best mortgages rates for 2017 can all be done online.
  4. Personal Finance

    Ways to Be Mortgage-Free Faster

    Getting rid of this debt faster has bigger benefits than you might think.
  5. Personal Finance

    5 Reasons To Save For A Big Mortgage Down Payment

    You may be anxious to buy a home, but taking time to save a large down payment has numerous advantages.
  6. Insights

    How Interest Rates Affect the Housing Market

    Understand how rate changes can affect home prices and learn how you can keep up.
  7. Personal Finance

    Reduce Interest With An All-In-One Mortgage

    "Offset" mortgages combine a checking account, home-equity loan and mortgage into one account.
  8. Personal Finance

    Make A Risk-Based Mortgage Decision

    Find out how to choose which mortgage style is right for you.
  9. Investing

    Understanding The Mortgage Payment Structure

    While a mortgageā€™s size and term set the baseline, the interest, taxes and insurance all influence the amount of the monthly payment.
  1. Mortgage

    A debt instrument, secured by the collateral of specified real ...
  2. Mortgage Rate

    The rate of interest charged on a mortgage. Mortgage rates are ...
  3. Second Mortgage

    A type of subordinate mortgage made while an original mortgage ...
  4. No-Cost Mortgage

    A mortgage refinancing situation in which the lender pays the ...
  5. CMG Plan

    A mortgage plan in which a borrower's mortgage is structured ...
  6. Mortgage Banker

    A company, individual or institution that originates mortgages. ...
Trading Center