“Definition: – The (nominal or arithmetic) average rate at which a debt is paid is the (monetary or mathematical) expectation of the future (nominal or arithmetic) payment from the lender in the future (monetary or mathematical) interest rate.” – Benjamin Franklin, 1757
You must be wondering how a person can expect a higher rate of interest on his future loan if his past has not been a successful one and it’s just been a loss of money and time? This is where it all starts.
The present interest rate will be lower than the future payment if a person has experienced a good financial experience or good paying transactions. In this case, the future interest rate is less than the future payment as an estimate of the future payment. For example, if the future payment is $100 but the future interest rate is 9%, that is a lower payment. If the future payment is $200 and the future interest rate is 10%, that is a lower payment as well.
Because the future payment is lower than the future payment, the lender has a lower expected value of what is owed to him on the loan. A good paying transaction is likely to lead to future payments of a higher amount and therefore a lower interest rate and thus a lower monthly payment. However, when the future payment is lower than the future interest rate, there is a higher value of the future payment because of the higher interest rate, which means that a lender will charge more money for the loan to pay off that loan.
This is what happens in a mortgage when the value of the loan is higher than the value of the house is. Thus, the lender is more than happy to charge more money for the loan because he knows he is making more money on the loan than he has to pay.
Thus, the value of future payments is very important in the mortgage lending business. It is not enough that the lender will charge a higher interest rate but the value of future payments has to be less than the value of the future interest rate to be profitable to the lender.
The lender should make sure that the interest rate will always be equal to or at least equal to the future payment of the loan. so that the future interest rate will always be lower than the future payment. if not, the lender should not charge more money for the loan and he will have the money to continue to make future loans.
This theory is also used in the case of home mortgage loans. Since home loans are secured loans and they have a higher risk than unsecured loans, lenders want the borrower to pay up front a lower amount of money than he expected to pay for the loan.
So if you are a homeowner, your lender is trying to protect himself by charging you a higher rate of interest on your home loan. It is an attempt to keep you from defaulting on your loan and leaving him no money. This is why the future payment is so important in mortgage lending.
It is important to know that if your loan is secured, your future payment will always be less than what you expected. Therefore, the value of the future payment in your mind will always be smaller than the value of the future interest rate.
If your mortgage is a secured loan and you expect to pay a lower amount of money for the loan, then the future payment is going to be lower than the future interest rate. Therefore, your future interest rate will be lower than the future payment.