What is a Paydown Factor
A paydown factor is the portion of cash subtracted each month from the principal of a loan divided by the original principal of the loan. Paydown factors can be calculated monthly and may be included in monthly statements. A paydown factor is also an important metric that is commonly observed when analyzing structured products.
BREAKING DOWN Paydown Factor
A paydown factor helps a borrower or investor to gain an understanding of the paydown rates involved with various credit products. Borrowers can calculate a monthly paydown factor to analyze the principal being paid each month. A paydown factor is also an attribute that is commonly reported when analyzing structured products and specifically mortgage-backed securities (MBS).
Loans provide a basic example for calculating a paydown factor. Some lenders may include a borrower’s paydown factor in their monthly statements each month. The paydown factor shows the amount of principal paid in the previous month divided by the original principal value.
For example, a borrower with a $100,000 mortgage loan paying a 4% annual rate of interest over fifteen years will make monthly payments of $592. The amortization schedule factors in the borrowers 20% down payment and amortizes $80,000 over the life of the loan. In the first month the borrower would pay approximately $267 in interest with a principal payment of $325. The paydown factor for the borrower’s first payment would then be $325/$100,000 or 0.33%.
Structured Credit Products
Structured credit products typically include a portfolio of loans with varying credit qualities. Generally these products will be comprehensively grouped by a target risk level based on the underlying credit qualities of the loans. The paydown factor can be a good metric for analyzing the performance of these investments since it provides an indicator for the level of principal being paid down across the portfolio. Calculating the paydown factor for a portfolio of loans aggregates the calculation to include the total principal paid monthly divided by the total comprehensive principal issued to borrowers.
Mortgage-backed securities commonly report paydown factors monthly. If a mortgage-backed security reports a steady paydown factor over time then that is a good indication that the loans are not at high risk of delinquency or default. A significantly decreasing paydown factor can be a signal of increasing risk on the portfolio. If borrowers in the MBS are consistently reporting payment delinquencies then a lower overall amount of the total portfolio principal will be paid down and the paydown factor will show a significant decrease.