Equal Installment Interest-Only Loans

To learn more about the various configuration options when setting up this loan type, refer to Configuring an Equal Installment Interest-Only Loan.

Overview

Interest-only equal instalment loans that have an equal payment amount that consists only of the interest. In other words, the interest amount will be equalized no matter how many days are in the month or in between the payments. No principal is allocated on the repayments schedule; instead, the principal is kept in the principal balance at the account details level.

For example: an organization may want to offer a buy-to-let loan where their end customer pays only the interest, and they want to ensure predictability and offer them an equal monthly payment. No principal will be collected until the maturity of the loan.

Interest-only equal installment loans are set up so your regular payments cover only the interest that's built up. No part of your payment goes toward reducing the original loan amount. The full principal amount remains outstanding, tracked as the loan's principal balance. Usually, clients are expected to pay back this entire principal balance in full at the end of the loan term, through a separate payment. However, you can also choose to reduce the principal balance throughout the loan's life by making extra principal payments. This will then lower the total amount due for your remaining installments.

A key feature of this loan type is that your total installment amount stays the same, even if the length of each repayment period varies (for example, different numbers of days in each month). Each monthly payment amount remains consistent. We achieve this by calculating the monthly total due as if all installments have a uniform number of days (for example, 30 days per month).

However, the actual interest that accrues will reflect the exact number of days in each period. This real interest accrual is shown in the accrued interest balance and at the payment schedule level. This can create a difference between the actual interest accrued and your fixed installment amount. This difference will cause fluctuations in the closing balances of each installment, affecting the internal interest balance.

Payment calculation

The consistent monthly total due (PMT) for these loans is calculated using the following standard financial formula:

PMT = -((interest rate/12), NPER, PV, -FV , Type)

Where:

• PMT: The monthly payment.
• Interest rate: The required loan interest rate.
• NPER: The required total number of payments for the loan.
• PV: The present value throughout the loan lifecycle. This refers to the current closing balance of the loan at that point in time. This balance inherently includes any accrued interest amount, which can fluctuate due to overpayments or underpayments relative to the actual interest accrued.
• FV: The future value, representing the principal amount outstanding at the close of the loan.
• Type: The optional type. A value of '0' (or omitted) indicates payments are due at the end of the period.

Example: interest accrual

Consider a loan with a Day Count Method = Actual/365, where the installment duration varies based on the actual number of days in the interval, while the Total due remains fixed.

Loan amount: 150000
Interest rate: 10% per annum
Number of instalments: 5
Disbursement date: 01/01/2023
First repayment due date: 01/02/2023

• Calculated Total Due (PMT): £1,250 (This is the fixed monthly payment derived from the PMT formula, assuming a standard number of days per month for scheduling purposes).
  • PMT = - ( 10%/12 , 5 , 150000, −150000 , 0)
  • Since the loan account is at its inception, its Present Value (PV) is equal to its Future Value (FV).

Instalment 1 (01/01/2023 until 01/02/2023):

• Period duration: 31 days
• Interest accrued: 150,000 * 10%/365 * 31 days = £1273.97
• Total expected (fixed PMT): £1250

In this instance, the customer's payment of £1,250 is less than the actual interest accrued (£1,273.97). The difference of £23.97 (£1,273.97−£1,250.00) will remain unpaid in the internal interest balance, causing it to increase.

Instalment 2 (01/02/2023 until 01/03/2023):

• Closing balance after installment 1 repayment: £150,000+£1,273.97−£1,250.00=£150,023.97
• Period duration: 28 days
• Interest accrued: £150,023.97×(10%/365)×28 days=£1,150.87
• Total expected (fixed PMT): £1,250.00
  • Here, the customer's payment of £1,250 is more than the actual interest accrued (£1,150.87). This surplus will reduce the outstanding amount in the interest balance.
• Previous interest balance = £23.97
• Interest balance after interest application on instalment 2 = £23.97+£1,150.87=£1,174.84
• Interest balance after repayment of instalment 2 = £1,174.84−£1,250.00=−£75.16

This example illustrates that while the scheduled payment remains constant, the actual interest accrued varies with the number of days in each period. This leads to fluctuations in the internal interest balance (positive when accrued interest exceeds the payment, negative when the payment exceeds accrued interest), ensuring that the borrower ultimately pays the exact interest accrued over the loan's lifetime.

Supported interest types for interest-only loans

Interest-only loans support different interest calculation methods that impact how the Interest Accrued Expected figure, which represents the actual interest anticipated to accrue over the specific period of an installment, is determined for each instalment.

Below are the interest calculations for the supported interest types:

• Simple interest: For simple interest, the Interest Accrued Expected is calculated directly based on:
  • The Closing Balance Expected at the start of the period
  • The annual interest rate
  • The exact number of days in the interval.

Interest Accrued Expected=Closing Balance Expected×(IR/Days in Year)×Number of days in interval

• Compound interest: With compound interest, the calculation accounts for the compounding effect over the period, using a daily interest rate.
• Interest Accrued Expected=Closing Balance Expected×((1+Daily IR)^Number of days in interval−1)
  Where: Daily IR=Annual IR/Days in Year

Pre-payments and over-payment allocation logic

• Pre-payment: An amount paid in advance which is smaller than the installment Total Due.
• Over-payment: An amount paid in advance which is bigger than the installment Total Due.

It is crucial to understand how repayments are allocated. Here's a breakdown of the different ways payments can be applied and their impact:

Custom repayments on the principal

This method allows you to apply funds exclusively to the loan's outstanding principal balance via custom repayments.

• When a payment is made this way, it acts as a prepayment or overpayment directly reducing your principal.
• Crucially, any upcoming scheduled instalment remains unaffected and will still need to be settled with its next regular repayment.

Regular repayments on upcoming installments

When you make a repayment that is intended to cover or exceed a future scheduled installment:

• If the prepayment is for a future installment, it will first be used to fully settle the Total Expected amount of that upcoming installment.
• Any remaining amount from the prepayment, after covering the instalment, will then be allocated to the principal balance.

Handling partial payments and excess funds

• If your prepayment amount is less than the Total Due of the upcoming instalment, it will partially settle that installment.
• If you then make a subsequent repayment for that same upcoming instalment and there's an excess amount beyond what's needed to fully settle it, this excess will be treated as an overpayment and allocated to the principal balance.

Impact on loan schedule

• When an overpayment directly reduces the principal balance, the system recalculates the loan schedule to reflect this change. This results in a new Payment (PMT) being computed for the remaining installments, using the Reduce Amount per Instalment prepayment recalculation method. Consequently, your future regular payments will be adjusted downwards.
• PMT adjustments are solely dependent on a principal overpayment. If prepayments are allocated only to an upcoming pending instalment without directly reducing the principal balance, the PMTs of the remaining installments will not be adjusted.
  The expected closing balance on your schedule is updated to reflect the actual closing balance after the overpayment.
• Consequently, the expected interest accrued for all subsequent instalments will be recalculated.

Interest-only schedules

The schedules for interest-only loans have distinct characteristics when compared to those of capital repayment mortgages, primarily due to how principal is managed and interest is calculated.

Here are the key features of an interest-only loan schedule:

• No principal amortisation: As previously described, the schedule for interest-only loans does not include any amortisation of the principal balance. This means the principal amount remains constant throughout the loan term on the schedule, with repayment typically expected at maturity.
• Interest-only specific columns: To provide greater transparency and accuracy, two columns specifically for interest-only loans are included in the schedule:
  • Interest Accrued Expected: Calculates the anticipated interest based on the actual number of days within each specific instalment interval.
  • Closing Balance Expected: Displays the projected loan balance (Principal Balance + Interest Balance) after the timely repayment of each instalment.
• Calculation of Closing Balance Expected: The calculation for the Closing Balance Expected is as follows:
  • For installment 1: It is derived from the initial Principal Balance plus the expected interest accrued for that period, minus the Total Due for the first installment.
    • Closing Balance Expected Installment 1​=Principal Balance+Interest Accrued Expected Installment 1​−Total Due Installment 1.​
  • For installments 2 onwards: Calculated by taking the Previous Expected Closing Balance from the prior instalment, adding the Interest Accrued Expected for the current installment, and then subtracting the Total Due for the current instalment.
    • Closing Balance Expected Installment N​=Previous Expected Closing Balance+Interest Accrued Expected Installment N​−Total Due Installment N. ​
• Impact of principal overpayments: The Closing Balance Expected is dynamically updated to reflect any principal overpayments made. This reduction in the expected balance has a direct impact on subsequent interest computations, leading to a decrease in the total interest paid over the life of the mortgage.

Do not accrue late interest option

When Do not accrue late interest is enabled at the product level, the closing balance expected will not be updated in the case of late repayments. The subsequent interest computations are done based on the closing balance expected throughout the entire loan lifecycle, with the only exception being scenarios where the principal balance is decreased by overpayments.

The do not accrue late interest feature was specifically implemented to support the Interest from Arrears Decoupling logic. It was crucial to prevent the duplication of interest amounts that would occur if interest were calculated both on the schedule (based on outstanding balances) and separately as interest from arrears (based on overdue total dues). However, the do not accrue late interest option can also be used independently, though it's important to note that when used this way, interest from arrears won't be computed at all.

Broken interest / initial payment adjustment

For more information, refer to Initial Payment Adjustment.

Payment holidays

For more information, refer to Payment Holiday.