How Do Home Loans Work?
Principal – The total amount borrowed or owed on any type of loan is called the principal. Making monthly payments on a basic fixed-rate loan will gradually reduce your principal.
Interest Rate – An interest rate is a rate that is charged for the use of money. In the Philippines it is calculated as an annual figure even if the repayment schedule is not yearly. For example, home loans are advertised with an APR (Annual Percentage Rate) of 2.9% even if the payments are spread out over three years. The interest rates charged by banks in the Philippines are determined by the Prime Lending Rate of the Bangko Sentral ng Pilipinas (BSP). Say for example the PLR is 6% and the interest rate for a loan with a “BLR-2%” would be 4%.
Loan Term – This is the length of time or period wherein you can repay your housing loan. The usual term for housing loans in the Philippines is up to 20 years. You can apply for a home loan at Bangko de Oro (BDO) for a minimum of P500,000.00, you can get up to 80% of the appraised value of the property with a loan term of up to twenty years.
Here is an example:
You are going to apply for a housing loan of P500,000.00 which will be payable in 20 years. Then you will agree to an interest rate of 4% per annum (BLR is at 6% so: 6%-2%). The home loan amount is P500,000.00, the interest rate is 4% per annum and the loan period is 20 years. Banks in the Philippines calculate the interests on home loans monthly. To illustrate how your first home loan repayment is calculated here is a sample computation:
Principal loan is P500,000.00
4% interest per annum = .33% monthly interest (4% divided by 12 months)
Your interest charge for the first month will be P1,650.00 because you applied the .33% monthly interest rate to your Principal loan which is P500,000.00
Getting Your Monthly Repayment Schedule
Now that you know your first month’s interest charge you can have an idea about your repayment schedule. The interest charge at P1,650.00 each month may go up or down depending on your loan agreement with the bank. The extra payment will help in reducing your debt (the loan principal balance). Your loan for the second month will go down because you paid a little extra on your first month and because the interests on your home loan is calculated based on the amount that you owe.
Banks base the amount that you need to pay monthly by using an “amortization formula”. By using such formula you would be able to repay your loan and all its interest upon loan maturity. Here is a rough calculation based on the figures above.
Monthly Repayment = P3,725
Interest: P1,650 (P500,000.00 x .33% = P1,650.00)
Principal: P2,075 (P3,725 – 1650 = P2,075) Leftover after paying the interest
By the 2nd month the loan balance will be:
P500,000 – P2075 = P497,925
P497,925 x .33% = P1,643 (2nd month’s interest payment)
Note: Rate of interest is also subject to monthly tax and insurance
Love this post? Want to learn more about home loan? Check out our post on the things that affect your home loan interest rate.