The term "paydown" has a couple of related meanings in the financial world, all of them tied to the business of loans and especially to mortgages. In the world of finance, people may refer to the paydown factor, which is a way of reporting on the performance of mortgage securities. For the individual, the idea of paying something down most likely references standard monthly payments or larger monthly payments that help to pay off a loan, and, if the payment is larger, it may pay principal amounts earlier.
Mortgage securities are similar to bonds and are investments in a group of mortgages. Government or related agencies often issue them and people are reimbursed for their investments as the individuals owning the mortgages pay off their loans. Some of the agencies that issue mortgage securities also must provide monthly reports to security owners, which may include something called a paydown factor.
A paydown factor is an accounting of the money received by mortgage holders which lists the principal amounts still owed on loans. Any payments to principal undergo a complex formula, which then demonstrates how much money is still owed. When the market is good and mortgage holders are regularly making their payments, this “factor” should show a decreasing amount of money owed monthly, though issuing new mortgages might change this.
Each month a mortgage holder makes payments, the loan is recalculated. Total amount owed may change, unless the mortgage holder is only making interest payments, and in ideal circumstances, each monthly payment pays down part of the mortgage. Borrowers looking at monthly mortgage statements should see a descending balance.
Many financial advisers recommend that the balance will decrease faster if people tighten their belts, when at all possible, and increase paydown amount. Instead of simply sticking to the minimum payment, making greater payments to the principal of the loan can be of considerable use in ending a payment obligation sooner. People will also pay less interest overall.
This could be especially important if the loan is upside down, which means the loan amount is higher than the assessed level of the house. Budgeting a larger paydown each month could eventually mean holding equity in the home, instead of simply holding a loan that would not be repaid with the home’s sale. It is not always possible for people to manage much higher payments each month. Some financial advisors recommend getting creative and increasing payments by small amounts, or making a yearly payment, especially if people get tax refunds from holding mortgages.
Ultimately, the paydown can be a useful term to understand for investors and private homeowners or mortgage holders. Both of these groups are happiest when statements about loans reflect that paydown amounts are reducing the size of loans.