What Is a Paydown?

A paydown is a reduction in the overall debt achieved by a company, a gover𓆉nment, or a consumer. In business, it often involves issuing a round of corporate bonds for less than the previous issue. In that way, the company reduces its debt load. For a consumer, a paydown can mean making a larger payment on a mortgage, car loan, credit card, or any other kind of debt to reduce the outstanding principal.

Understanding a Paydown

The goal of a paydown is to reduce the amount of principal owed on a debt. A payment on an interest-only mortgage loan, for example, would not qualify as a paydown. Nor would a payment on a credit card balance that does not exceed the regular minimum monthly payment plus the total of any new purchases. Th🍒at's because the principal of the debt is not shrinking.

How Bond Paydowns Work

A company or a municipal authority can implement a paydown by issuing a new round of bonds with a total face value that is less than its last round of bonds, which have reached their maturity date. Because outstanding bonds represent debt owed by the company, paying off $1 miꦉllion in bonds and issuing only $500,000 worth of new bonds results in a lower debt load. The $1 million debt has been paid in full, and the new debt is only half the previous amount.

How Loan Paydowns Work

When a borrower pays more𓂃 than the minimum required payment on a loan, the excess can be directed toward paying down the principal. This lowers🌜 the principal that remains due and also means less interest will accrue in the future. Even a single additional principal payment will reduce interest for the life of the loan.

The Paydown Factor in Accounting

The term paydown is also used in accounting. The paydown factor is a way to assess the overall performance and risk level of financial products suc🔥h as mortgage-backed securities or a portfolio of loans over time. In times of economic prosperity, borrow✨ers tend to pay their debts at a steady pace. But in difficult times, more of them may become delinquent in their payments, a fact that will be reflected in a deteriorating paydown factor.

Example of a Consumer Paydown

A common example of a consumer paydown is making extra principal payments toward a mo𒁏rtgag𝕴e.

Suppose a homeowner has 20 ye𝕴ars of payments remaining on a $300,000, 30-year mortgage with an interest rate of 5%. Their n🧜ormal monthly payment (principal and interest) will be about $1,610.

However, if they were to contribute an extra $100 a month toward principal, they'd save about $15,250 over the life of the loan and pay it off nearly two years sooner.

If they were able to pay even more than $100 extra each month, they'd save even more and pay off their mortgage even sooner.