What Is a Paydown?
A paydown is a reduction in overall debt achieved by a company, a government, or a consumer.
In business, it generally is achieved by issuing a round of corporate bonds for less than the previous issue. The company has reduced its debt load.
- A paydown is a reduction in the principal amount owed.
- Companies achieve a paydown by issuing a new round of debt that is smaller than a previous round that has reached maturity.
- Consumers can achieve a paydown by paying more than the minimum monthly amount due on a debt.
For a consumer, a paydown by a mortgage owner means paying more than the minimum monthly principal payment due in order to reduce the debt, repay it earlier, and save on the interest paid over the life of the loan. It could equally mean repaying more than the current installment due on a car loan, credit card debt, college loan, or any other type of debt.
Understanding the Paydown
A paydown means a reduction in the principal amount of debt. A payment on an interest-only mortgage loan, for example, would not qualify as a paydown. A monthly payment on a credit card balance that does not exceed the amount of interest owed plus the total of any new purchases made is not a paydown. The principal owed is not shrinking.
Early Debt Paydown and Total Interest
When a borrower pays more than the minimum required payment that covers the standard principal and interest amount, the excess can be directed towards paying down the principal. This immediately lowers the principal due. That means less interest will accrue in future.
A credit card payment must exceed the interest owed plus the cost of any new purchases made in order to qualify as a paydown.
The monthly interest owed on a loan is determined as a percentage of the principal currently owed. Thus, a single lower principal payment results in lower accrued interest for the life of the loan. Over the life of a large loan such as a mortgage, the savings are significant.
The Paydown in Corporate Bonds
A company or a municipal authority can implement a paydown by issuing a new round of bonds with a total face value that is less than the value of its last round of bonds that reached their maturity date. Since outstanding bonds represent debt owed by the company, paying off $1 million in bonds and issuing only $500,000 worth of new bonds results in a lower debt load. The $1 million debt has been paid in full, and the new debt is only half the previous amount.
The Paydown Factor in Accounting
In accounting, the paydown factor is represented using a complex mathematical formula to determine the amount of principal remaining to be paid within a group of mortgages.
In times of economic prosperity, this number generally moves down over time to reflect the payments by borrowers. The downward trend may be interrupted when new mortgages are issued, or when economic conditions deteriorate, placing pressure on borrowers.