The previous edition as at 1st June 2015 can be found in the archives Click HERE The index is low on the right of the archive blog page.
Ongoing rewrites, updates and additional material are noted on the LATEST UPDATES page.
7th May 2016
This page has been heavily edited today.
It is shorter and easier to understand.
I am going to try to make it better again shortly  now late in 2017.
If you find it difficult it may be a good idea to try reading the Actuarial Maths version which ties in very nicely with the economics papers.
It is a good idea to print the illustrations.
FOR THE REPAYMENT OF DEBT
L = the debt / loan / mortgage value
If P = 7 p.a. and L = 100, then:
Let's place r% on the same axis so that if an 'X' is placed at r% the
position of the 'X' represents a standing loan.
e% p.a. = the percentage rate at which debt servicing payments 'P' p.a. will increase every year. If ‘e’ is negative the payments are falling.
Example: if P = 100 and e% = 3% p.a. in the following year the value of P = 103, in any currency.
Now we have, for the LP (level
Payments) loan, the position of the ‘X’ indicates that e% p.a. = 0% p.a. This
is an LP (Level Payments) loan as long as the ‘X’ stays on the vertical, Yaxis, meaning that e% = 0% every year.
We will want the 'X' to be to the left
of that AEG% line showing the repayments are rising less quickly than average
borrowers' earnings, or AEG, are rising. Whether or not AEG is the right index
to use will be discussed later.
As just mentioned, the exact definition of AEG% p.a. is something that needs careful thought. But as long as the 'X' is far enough to the left of the AEG% line, as long as the difference between e% and AEG% p.a. is large enough the great majority of borrowers will have earnings which are rising faster than the payments 'P p.a.' are rising.
The position of the 'X' describes the current value of P% and of e%. And the position of the 'X' has a visible horizontal distance from the AEG% p.a. line and a visible vertical distance from the standing loan line  two safety margins to be aware of. Later, these distances will be given names and included in the risk management equation.
USING THE CHART
This means that the ratio P/L and the value of P% p.a. never changes. It stands still. Normally P% p.a. rises every year as the loan gets repaid. This is because as 'L' reduces but 'P' does not rise, or does not rise as fast, the ratio P/L rises. But if the loan and the payments are both rising at the exact same pace, the loan will never get repaid.
It is like a race in which the payments increases are chasing the loan size 'L' increases. If both are rising at the same rate neither side wins. It is a dead heat.
The same thing can happen when AEG% p.a. is not rising. In fact, AEG, (earnings), may be falling. But this time, both the Loan Size 'L' and the Payments 'P' are falling. This means that 'e% p.a.' is negative.
In this case we have to extend the standing loan line to the left of the YAxis:
As already explained, for standing loan to exist, P / L = Constant. That is saying that the payments 'P p.a.' must rise or fall at the same pace as L.
From Equation (i) which was:
To create a standing loan P% has to be a constant.
P% = K
where K has some constant value.
The 'X' is then on the Yaxis at P% = r%. See FIG 0
In the next table the repayments interest r% = 7% as before but P% starts at 6% which in this example is 6,000 p.a. So the loan ‘L’ rises by 1% p.a.
For there to be a standing loan the payments 'P p.a.' must catch up at the end of the year and rise by 1% in order to do that.
FIG 1  Standing Loan when e% = 0% and e% = 1%
We can move the 'X' another 1% below r% making P% = 5% p.a. or 5,000 in this example, as in Table 2 below. This gives a third ‘X’ on the chart in which the loan rises by 2% and so the payments 'P' must rise by 2% at year's end meaning that e% has to go to 2% p.a. to catch up. See Table 2 and FIG 2 below.
This can be repeated for as many values of the entry cost as we wish.
This also works. The loan is rising as fast as the payments. This time the 'X' is to the left of the YAxis. See FIG 3
This way it gets easier for most people to repay every year and so the arrears rate is low. This is a key feature of a safe repayments schedule.
PART 2
Here I have added three new letters, C%, D%, and I% to the chart.
The objective is to find an equation which gives us the value of P% for position 'X' on the chart.
NOTE: The AEG% p.a. component of r% preserves the value of a debt (or of savings) in units of NAE. As NAE rises in money value, it takes AEG% p.a. of the interest rate r% added to the loan 'L' to retain the value in units of NAE.
Example: 1 NAE = 100 p.a. in any currency where people are earning 100 per annum.
Take a loan where L = 100
Let AEG% p.a. = 6%.
At year's end 1 NAE = 106.
For the debt to be 1 NAE also 6 must be added in interest to the loan L of 100.
Then L = 106 = 1 NAE.
In general terms a part of the interest r% has to be used to add AEG% to the loan. We can call this the core rate of interest where the core rate is AEG% p.a.
If r% < AEG% then the loan L will fall in value compared to NAE.
The true rate of interest I% will be negative.
So we have three variables to consider: 'C%', 'D%', and 'I%', as seen in FIG 4 above, and again, in FIG 5 below.
In FIG 5 we can link all three variables together with equilateral triangles, like this:
Hence by adding up the vertical distances we can see that:
P% = C% + D% + I%  Ingram’s Safe Entry Cost Equation
WHAT THIS TELLS US
If all three variables on the right hand side of the equation are unstable or if 'C%' is unstable then 'P%' will also be unstable. That spells trouble.
If 'D% p.a.' is allowed to go negative and stay negative for very long then there will be a lot of arrears.
Ongoing rewrites, updates and additional material are noted on the LATEST UPDATES page.
7th May 2016
This page has been heavily edited today.
It is shorter and easier to understand.
I am going to try to make it better again shortly  now late in 2017.
If you find it difficult it may be a good idea to try reading the Actuarial Maths version which ties in very nicely with the economics papers.
It is a good idea to print the illustrations.
GENERAL EQUATIONS
FOR THE REPAYMENT OF DEBT
DEFINITIONS  for later reference only
ILS Models  The Ingram Lending and Savings Models for safe lending and savings.
ILS Models  The Ingram Lending and Savings Models for safe lending and savings.
· NAE
 National Average Earnings / Incomes
· AEG%
p.a.  The rate of Growth of NAE.
· AEG%
p.a. stands for the Average Earnings Growth % p.a.
· r%
 the rate of interest also known as the nominal rate of interest.
CONVENTION
Sometimes it simplifies
equation reading and writing if the suffix ‘p.a.’ is dropped.
r% is split into two
parts:
r% = AEG% + I% (a)
· I%
is called the TRUE rate of interest, or the marginal rate above AEG%
r% = AEG% +I% ....(b)
NOTE: It is possible
for I% to be negative if AEG% > r%
· e% =
the annual rate of increase in the debt servicing payments, P p.a.
There is no rule which
says that the repayments P p.a. have to be fixed.
· D% = AEG%
 e% ...........(c)
Where ‘D%’ is the rate
of Payments Depreciation. D% p.a. is how much less quickly the payments
rise than AEG%.
· P% =
P/L x 100% so it is the payment P expressed as a percentage of the loan L
· C% =
the capital element  the rate of repayment of NAE  something not to be
understood yet.
MAIN MATHS
PART 1
Creating a Risk Management Chart
DEFINITIONS FOR IMMEDIATE USE
P = the current level of annual payments p.a.
Note: The definition of payments is the sum paid to service the loan. P may or may not be enough to reduce the loan or its value. That is something to find out.
Note: The definition of payments is the sum paid to service the loan. P may or may not be enough to reduce the loan or its value. That is something to find out.
L = the debt / loan / mortgage value
P% p.a. is the annual percentage
of the debt 'L' that is being paid by money payments 'P' p.a.
I often drop the 'p.a.' part as this is understood. This is easier to read that way:
I often drop the 'p.a.' part as this is understood. This is easier to read that way:
P
P% =  x 100%  (i)
L
I could have written:
P p.a.
P% p.a. =  x 100%
L
Let's place P% p.a. on the YAxis (Vertical Axis) of a chart.
CONVENTION:
No $, €, £, ¥ symbols are not necessary. The numbers work in any
currency.
EXAMPLE FOR USING P%
If P = 7 p.a. and L = 100, then:
P% p.a. = 7% p.a.
The lending industry usually refers to the traditional repayments
(annuity) model as a level payments (LP) model even though an interest rate
change creates a new level of payments.
When the annual payment 'P p.a.' made to service the loan not to change
at year's end the nominal interest rate r% has to be fixed.
STANDING LOANS WITH LEVEL PAYMENTS
and a fixed rate of interest r%
Let r% = Nominal Interest (the rate of interest).
If interest r% = 7% then the interest added to a loan of 100 is 7 in any
currency, making a loan of 107 at year's end.
If P% = 7% then every year the payment P = 7. This removes the interest
added reducing the year's end balance from 107 to 100, leaving the balance
unchanged at 100 as before. This is called a standing loan. It never gets
repaid. It ever rises either.
In general, there is a standing loan if P% = r%.
Now for something a little different.
We are deriving the General Equation for repayments of any kind of regular payments loan. For this
there is a different definition of a standing loan. We will come to that
shortly.
We do not have to specify that the repayments will be level. We can say
that they may rise every year at, say e% p.a.
e% p.a. = the percentage rate at which debt servicing payments 'P' p.a. will increase every year. If ‘e’ is negative the payments are falling.
Example: if P = 100 and e% = 3% p.a. in the following year the value of P = 103, in any currency.
We can add e% as the XAxis.
Now we can place an 'X' on the chart
such that 'X' has a value on the 'P% p.a.' axis and another vale on the 'e%
p.a.' axis.
The position of the 'X' describes the
current value of 'P% and 'e%'
The initial place of the 'X' on the
chart can be selected by the lender. The
'X' does not have to be on the vertical Yaxis. The 'X' can be placed anywhere.
But where is it safe to put it?
When we place the ‘X’ we must know that
the payments should not increase as fast as the rate at which the borrowers’
incomes are rising:
e% p.a., the rate of increase of 'P
p.a.' should be less than the rate of increase of a typical borrower's earnings,
Average Earnings Growth, AEG% p.a..
e% < AEG% p.a.
So we draw a line on the chart to
represent AEG% p.a.
Here, the 'X' is shown to the left of the AEG% p.a. line.
As just mentioned, the exact definition of AEG% p.a. is something that needs careful thought. But as long as the 'X' is far enough to the left of the AEG% line, as long as the difference between e% and AEG% p.a. is large enough the great majority of borrowers will have earnings which are rising faster than the payments 'P p.a.' are rising.
FIRSTLY
For safety, for management of the level of (risk of) arrears, the cost of payments will rise less quickly than the average borrower's
earnings.
If NAE was rising at 4% p.a. and interest rates were fixed, which is
about how things may have worked out in the 1900's when economies were not in
crisis, this 4% difference between AEG% p.a. (4%) and e% (0%) would put e% p.a. at 4% p.a. It was enough to keep
arrears under good control.
Of course, most payments are made monthly. Readers should just divide
the annual figure by twelve to get the monthly payment.
SECONDLY
We also need to know that the 'X' is high enough to repay the loan. If
the 'X' lies on the YAxis, meaning that the payments are scheduled to
be level and not rising or falling, it needs to be above the rate of interest
'r%'. This
means that some of the capital is being repaid.
If we move the 'X' off the YAxis, how will we know if it is high enough
to repay the loan?
We need to find a standing loan line at which level the loan will never be repaid. The 'X' needs to be high
enough above this line to repay the loan in the time available, say 25 years.
This is what the standing loan line looks like. Why it looks like that is
the next thing to find out. See FIG 1
FIG 1 Ingram's Risk Management Chart
The chart has two Axes, two straight dashed lines, one at 45 degrees
slope representing a standing loan line and one dashed vertical line
representing the current rate of AEG% p.a., and an 'X' whose position on
the chart describes the current state a specific regular payments
loan.
The position of the 'X' describes the current value of P% and of e%. And the position of the 'X' has a visible horizontal distance from the AEG% p.a. line and a visible vertical distance from the standing loan line  two safety margins to be aware of. Later, these distances will be given names and included in the risk management equation.
USING THE CHART
'X' has a value of e% and a value of P%  as any debt
repayments schedule has.
So there is always a
position of the 'X' which can represent ANY regular repayments schedule for any
kind of loan. Any place on the chart has a value for P% and a value for e%, both being
p.a.
Any position on the chart has two safety margins.
The vertical and horizontal safety margins for any repayments schedule
at any point in time can be read off the chart. Just find the e% and the P%
values and place the 'X' where it belongs.
In this example the 'X' lies to
the left of the AEG% p.a. line and above the
standing loan line, so that the debt is being repaid safely. The area to the left of
the AEG% p.a. line and above the standing loan line is the safe area for
placing the 'X'. The further the 'X' is placed from these two lines the safer the repayments
schedule will be.
These two distances are margins of safety because if the interest rate changes or the
value of AEG% p.a. changes either or both of those two distances may be reduced unless the position of the 'X' is actively managed in some way. We will come to that later. As long as the 'X' remains in the safe area and it does not hump up suddenly with 'e%' remaining below AEG% p.a. (to the left of the AEG% line) while staying above the standing loan line so that the debt will eventually be repaid. This raises a number of questions including how the lender will manage its cash flows, and they will be addressed later.
FINDING THE STANDING
LOAN LINE
In the next chart, an 'X' is placed at r% and
represents a standing loan. The 7% interest is being repaid using e% = 0% (Level Payments). To repay the
loan the 'X' has to be higher than the standing loan line  in this case it must be above r%, for example the position 'X_{1}' would repay the loan as long as r% did not rise too much.
To repay in 25 years 'X_{1}' would have a value of around 8.5%
p.a. Those used to be typical figures before central banks in the developed economies reduced interest
rates to below normal levels from around the year 2000 onward.
When the interest rate rises then the standing loan line also rises. Then to repay the debt on schedule the level of the ‘X’ jumps up to a new level. I.e. the annual cost of the loan servicing payments jumps up. The change is not scheduled and it may create arrears problems.
When the interest rate rises then the standing loan line also rises. Then to repay the debt on schedule the level of the ‘X’ jumps up to a new level. I.e. the annual cost of the loan servicing payments jumps up. The change is not scheduled and it may create arrears problems.
A possible alternative would have been for the ‘X’ to move to the right
and stay above the standing loan line. Maybe the AEG% p.a. line has also moved
to the right because higher interest rates are often linked to higher levels of
AEG% p.a. In any case, there is likely to be room to move the 'X' to the right. Doing that would reduce the level of arrears which normally rises sharply when interest rates increase. We will come to that later.
DEFINING THE STANDING LOAN LINE
The standing loan line is a line which, if the 'X' is placed anywhere on
it, the loan will never be repaid. If the 'X' happens to be on the standing
loan line then the value of the debt 'L' will be rising at the exact same e%
p.a. pace as the payments 'P' are rising.
This means that the ratio P/L and the value of P% p.a. never changes. It stands still. Normally P% p.a. rises every year as the loan gets repaid. This is because as 'L' reduces but 'P' does not rise, or does not rise as fast, the ratio P/L rises. But if the loan and the payments are both rising at the exact same pace, the loan will never get repaid.
It is like a race in which the payments increases are chasing the loan size 'L' increases. If both are rising at the same rate neither side wins. It is a dead heat.
The same thing can happen when AEG% p.a. is not rising. In fact, AEG, (earnings), may be falling. But this time, both the Loan Size 'L' and the Payments 'P' are falling. This means that 'e% p.a.' is negative.
In this case we have to extend the standing loan line to the left of the YAxis:
In this case where the 'X' is above the standing loan line but to the left of the YAxis, the mortgage
is being repaid even though the payments are falling every year. In this particular illustration, the level of payments 'P' is not very high because of the very
low nominal rate of interest of 3%. A low interest rate moves the standing loan line
down.
Here is a spreadsheet illustrating how that might work. In
the table and on the chart above, AEG% = 0% so that the AEG% p.a. line has moved
to coinside with the YAxis. I must redraw this chart to delete the letters AEG% because they should be below the YAxis.
This is how that position of the ‘X’ on the above chart looks in tabulation form.
As shown in this table, (with AEG% = 0% and e% =  4% p.a. in this example), the payments are falling every year and the debt is falling even faster, because the 'X' is above the standing loan line.
As shown in this table, (with AEG% = 0% and e% =  4% p.a. in this example), the payments are falling every year and the debt is falling even faster, because the 'X' is above the standing loan line.
In order to simplify the repayments table, all transactions occur at
year's end.
The balance at the end of each year is carried forward to the start of
the next year.
On this schedule the debt is paid off
in the 25th year.
Without wishing to explain this right now, please note that the
repayments start at 8,455 p.a.
Given this initial loan of 100,000, this means that P% starts at 8.455%
p.a.
The starting cost is called the Entry
Cost.
This entry cost is not far from P% = 8.5%.
P% = 8.5% would be about the right entry cost figure to repay the same
loan in the same 25 years, if the nominal rate of interest r% was fixed at 7%
p.a. and the repayments were level.
For some reason which the reader does not yet know, P% = 8.5% p.a. is a
kind of 'sweet entry cost' for the repayment of a home loan over 25 years.
Whatever the nominal rate of interest r% may be, this is normally a good
(fairly safe) level at which to start the repayments.
If that is the case, and the entry cost remains fairly stable as nominal interest rates vary, the size of new loans would be correspondingly steady, not rising much as interest rates fall too far because that would be high risk as we shall see later. But that is what lenders do right now. As interest rates fall they drop the entry cost, (risky), push up the size of new loans, (risky), and inflate property values making them likely to fall later  also risky. This is a high risk way to calculate the entry cost.
If that is the case, and the entry cost remains fairly stable as nominal interest rates vary, the size of new loans would be correspondingly steady, not rising much as interest rates fall too far because that would be high risk as we shall see later. But that is what lenders do right now. As interest rates fall they drop the entry cost, (risky), push up the size of new loans, (risky), and inflate property values making them likely to fall later  also risky. This is a high risk way to calculate the entry cost.
NOW GOING BACK TO
FINDING THE STANDING LOAN LINE
To find out where that standing loan line may be we have to do some
thinking.
As already explained, for standing loan to exist, P / L = Constant. That is saying that the payments 'P p.a.' must rise or fall at the same pace as L.
From Equation (i) which was:
P
P% =  x 100%  (i)
L
To create a standing loan P% has to be a constant.
P% = K
where K has some constant value.
The usual level payments system is special case when e% = 0%. It is when
P% = r% and both 'P' = a constant, r% = a constant, and 'L' = a constant. Neither P nor L changes
from year to year. They are both steady / fixed. The rate of increase of both P
and L is zero. See Table 0 below.
Table 0: The Standing
loan where r% = 7% and e% = 0% p.a.
ADD

SUBTRACT


Yr

LOAN

INTEREST

PAYMENT

BALANCE

P%

1

100 000

7 000

7000

100 000

7,00%

2

100 000

7 000

7000

100 000

7,00%

3

100 000

7 000

7000

100 000

7,00%

The 'X' is then on the Yaxis at P% = r%. See FIG 0
FIG 0
In the next table the repayments interest r% = 7% as before but P% starts at 6% which in this example is 6,000 p.a. So the loan ‘L’ rises by 1% p.a.
For there to be a standing loan the payments 'P p.a.' must catch up at the end of the year and rise by 1% in order to do that.
Now we see, in Table 1, as expected, that P% = a constant 6%. Every year. P%
= 6% See Table 1 below.
Table 1: e% = 1% p.a.
ADD

SUBTRACT


Yr

LOAN

INTEREST

PAYMENT

BALANCE

P%

1

100 000

7 000

6 000

101 000

6,00%

2

101 000

7 070

6 060

102 010

6,00%

3

102 010

7 141

6 121

103 030

6,00%

Fig 1 shows this on the Chart at position ‘X_{1}’. Now we have
two points on the graph, both representing a standing loan.
FIG 1  Standing Loan when e% = 0% and e% = 1%
We can move the 'X' another 1% below r% making P% = 5% p.a. or 5,000 in this example, as in Table 2 below. This gives a third ‘X’ on the chart in which the loan rises by 2% and so the payments 'P' must rise by 2% at year's end meaning that e% has to go to 2% p.a. to catch up. See Table 2 and FIG 2 below.
Table 2: e% = 2% p.a. P% = a constant 5%
ADD

SUBTRACT


Yr

LOAN

INTEREST

PAYMENT

BALANCE

P%

1

100 000

7 000

5 000

102 000

5,00%

2

102 000

7 140

5 100

104 040

5,00%

3

104 040

7 283

5 202

106 121

5,00%

On the Risk Management Chart this is how that looks  see X_{2}_{}
FIG 2 Standing Loan
at e% = 0%, 1%, and 2% p.a.
This can be repeated for as many values of the entry cost as we wish.
Every time the ‘X’ drops by 1%, it has to move 1% to the right to create a standing loan.
What if e% is negative?
In the next table e% = 1% p.a.
P% = constant at 8%.
Table 3: e% = 1% p.a.
ADD

SUBTRACT


Yr

LOAN

INTEREST

PAYMENT

BALANCE

P%

1

100 000

7 000

8 000

99 000

8,00%

2

99 000

6 930

7920

98 010

8,00%

3

98 010

6 861

7 841

97 030

8,00%

This also works. The loan is rising as fast as the payments. This time the 'X' is to the left of the YAxis. See FIG 3
FIG 3
EQUILATERAL TRIANGLE
Hence the Standing Loan Line forms an equal sided (equilateral) right
angled triangle. The two equal sides of the triangle are the two major axes, and the standing
loan line is the hypotenuse.
Because the two sides are of equal length, the standing loan line
crosses both the Yaxis and the Xaxis at the same value, r% as shown.
NORMALLY P% RISES
Normally if the loan is being repaid the loan gets smaller compared to
the payments. This means that P% rises every year. In the final year P%
>100% because if the final payment was equal to L (P% = 100%) that would not
pay off the interest added in that year. In the case of a 5year loan the repayments table
might look like this:
Table 4  A 5 year loan see
P% rising every year and ending at over 100%
ADD

SUBTRACT


Yr

LOAN

INTEREST

PAYMENT

BALANCE

P%

1

100 000

7 000

24 389

82 611

24,39%

2

82 611

5 783

24 389

64 005

29,52%

3

64 005

4 480

24 389

44 096

38,11%

4

44 096

3 087

24 389

22 794

55,31%

5

22 794

1 596

24 389

0

107,00%

In the final year loan outstanding is 22,794 but interest of 1,596 also has to be repaid. So P% is more than 100% in this last year.
A SAFE PLACE FOR THE 'X'
To make a loan affordable and safe the 'X' has to be sufficiently above the standing loan line so that it
gets repaid and it has to be sufficiently to the left of the AEG% p.a. line so that the payments increase more
slowly than incomes do.
This way it gets easier for most people to repay every year and so the arrears rate is low. This is a key feature of a safe repayments schedule.
Since no individual's income rises at the exact AEG% p.a. rate, and
since there could be some discussion about how the AEG% figure is calculated, the
'X' must be placed some distance to the left of the AEG% p.a. line.
SETTING THE MARGINS
The objective of reducing the rate of increase in the payments below AEG% p.a. is to prevent what lenders call payments fatigue, for
the majority, (say 95% or more), of borrowers and to ensure that the payments
are affordable.
With the traditional LP model when interest rates rise by 1% the cost of
the repayments may jump up by 10% or more.
With this new Ingram Lending and Savings (ILS) repayments model, even if the ‘X’ were to be moved 1% to the right of the YAxis, at e% = 1% p.a. it would be a decade before the payments reached that same level.
Because the 'X' would still be the same distance above the new, higher, standing loan line, calculations show that the loan will still be repaid almost on schedule.
I NEED TO SHOW THE CHART HERE
This means that the standing loan line forms an equal sided triangle (same length on both major axes) and it means that it crosses the vertical and horizontal axes at the same figure of r%. Remember that for Part 2 when we derive the Risk Management Equation using that information.
We have also placed an AEG% (Average Earnings / Incomes Growth) line on the chart. We know that this line moves to the left and to the right as the value of AEG% p.a. changes.
We know that we do not want the AEG% p.a. line to get too close to the 'X', especially in the early years. And we want the 'X' to be far enough to the left of the AEG% p.a. line to protect any borrowers whose incomes are not rising as fast as average.
With this new Ingram Lending and Savings (ILS) repayments model, even if the ‘X’ were to be moved 1% to the right of the YAxis, at e% = 1% p.a. it would be a decade before the payments reached that same level.
Because the 'X' would still be the same distance above the new, higher, standing loan line, calculations show that the loan will still be repaid almost on schedule.
I NEED TO SHOW THE CHART HERE
SUMMARY SO FAR
So far we have established the framework
of the Risk Management Chart, the fact that we can draw a standing loan line
which slopes downwards at 45 degrees. This means that and crosses both
Axes at r%, the level of the nominal rate of interest.
This means that the standing loan line forms an equal sided triangle (same length on both major axes) and it means that it crosses the vertical and horizontal axes at the same figure of r%. Remember that for Part 2 when we derive the Risk Management Equation using that information.
We have also placed an AEG% (Average Earnings / Incomes Growth) line on the chart. We know that this line moves to the left and to the right as the value of AEG% p.a. changes.
We know that we do not want the AEG% p.a. line to get too close to the 'X', especially in the early years. And we want the 'X' to be far enough to the left of the AEG% p.a. line to protect any borrowers whose incomes are not rising as fast as average.
PART 2
Derivation of the Main Equation
P% = C% + D% +
I%
All variables in the equation are p.a.
Both 'P%' and 'C%' are a percentage of the loan
balance 'L'.
In FIG 4, below, all four variables are displayed on one chart.
FIG 4  All Variables
Displayed
Here I have added three new letters, C%, D%, and I% to the chart.
The objective is to find an equation which gives us the value of P% for position 'X' on the chart.
NOTE the precise definition of D%:
D% = AEG%  e%  (ii)  all are p.a.
Or if you prefer, this can be rearranged:
e% = AEG%  D%
Which says that the rate of increase in the annual payments P p.a. is D%
p.a. less than AEG% p.a.
TRUE INTEREST 'I%'  THE DEFINITION
The nominal rate of interest has two components:
NOTE: The AEG% p.a. component of r% preserves the value of a debt (or of savings) in units of NAE. As NAE rises in money value, it takes AEG% p.a. of the interest rate r% added to the loan 'L' to retain the value in units of NAE.
Example: 1 NAE = 100 p.a. in any currency where people are earning 100 per annum.
Take a loan where L = 100
Let AEG% p.a. = 6%.
At year's end 1 NAE = 106.
For the debt to be 1 NAE also 6 must be added in interest to the loan L of 100.
Then L = 106 = 1 NAE.
In general terms a part of the interest r% has to be used to add AEG% to the loan. We can call this the core rate of interest where the core rate is AEG% p.a.
If r% < AEG% then the loan L will fall in value compared to NAE.
The true rate of interest I% will be negative.
REMINDER
The true interest rate ‘I%’ is the marginal rate above
AEG% p.a.
By this definition:
r% = AEG% + I%
or we can write:
I% = r%  AEG% ............(iii)
This definition fits nicely on the chart, on the XAxis, as shown above and again below.
So we have three variables to consider: 'C%', 'D%', and 'I%', as seen in FIG 4 above, and again, in FIG 5 below.
In FIG 5 we can link all three variables together with equilateral triangles, like this:
FIG 5  Derivation of the General Equation for P%
Note that I have constructed two small equalsided
right angle triangles by adding the double arrowheaded lines:
One triangle has two equal sides of length I%, and above that,
One triangle has two equal sides of length D%.
Hence by adding up the vertical distances we can see that:
P% = C% + D% + I%  Ingram’s Safe Entry Cost Equation
IMPORTANT NOTE:
Although this equation can be used to estimate a safe entry cost by
ensuring that the variables 'C%' and 'D%' are large enough at outset, this
equation has a general use in analysing the component parts that make up the
value of ‘P%’ for ANY repayments schedule for ANY debt.
WHAT THIS TELLS US
This means that. just as molecules are made up of atoms, ALL debt repayment schedules have these three elemental parts,
whether intentionally or not. They all have a value of 'I%' and of 'D%' and of
'C%' at all times.
We can use this to define any kind of loan repayments agreement / schedule. It is a general equation for lending and risk management. Risk is managed by managing 'C%' and 'D%'.
There are different ways to allocate the various values to the three variables. How that is done is a function of the lending contract and of the regulations limiting what the contract can say or do.
We can use this to define any kind of loan repayments agreement / schedule. It is a general equation for lending and risk management. Risk is managed by managing 'C%' and 'D%'.
There are different ways to allocate the various values to the three variables. How that is done is a function of the lending contract and of the regulations limiting what the contract can say or do.
There are no debt repayment schedules on earth which have no value of
'e%' or no value of 'P%'. Since all debt repayment schedules have a value 'P%' and
a value of e%, they also have a value for 'C%', 'D%', and 'I%'.
If all three variables on the right hand side of the equation are unstable or if 'C%' is unstable then 'P%' will also be unstable. That spells trouble.
If 'D% p.a.' is allowed to go negative and stay negative for very long then there will be a lot of arrears.
It is time to look at how to manage these variables safely and to find the safe minimum values for C% and D%.
That will be done on another page of this website  as yet not written. But it has all been worked out and is waiting to be published. There are examples of what can be achieved on some linked pages. For example:
NEW FINANCIAL PRODUCTS RESULTING
and
There is some way to estimate the upper and lower limits of I% which concludes that I% always averages somewhere between 1% and 4% over the long term in order to create a limited rate of inflation.
This means that D% = 4% should be enough in most cases to prevent P% from having to leap upwards which is what happens with LP mortgages using variable rates of interest.
Here is why:
P% = C% + D% + I%
Let I% rise by a maximum of 4% and remain at that high level.
For P% and C% to be unaffected D% must fall by 4%
So a typical safe loan might be given by:
P% = 1.5% (repays in around 25 years) + 4% + 3% where I% = 3% (assumed) even if it is lower or higher by a little.
So P% Safe Entry Cost is given by:
P% = 1.5% + 4% + 3% = 8.5%
This is the entry cost used in almost all tests of this new ILS Model for Housing Finance.
A fairly stable entry cost of 8.5% consuming, say 30% of the earnings of a single borrower, we get a loan of 3.5 times annual earnings. It is assumed that lenders will select net earnings after deducting commitments like credit card payments and other loans...
Exactly how they apply this equation is up for discussion.
But clearly it is risky to lend a lot more and it is not necessary to lend a lot less. the value of P% is not a function of r% or of AEG%.
Property loans will have a value which rises with NAE. This meets the requirements given for a financially stable property sector which is also low in arrears.
The payments 'P' rise annually as fast as NAE rises less the scheduled reductions of D% p.a. But macroeconomically the lending sector as a whole comprises new and old borrowers so the amount of aggregate earnings devoted to mortgage repayments will tend to rise alongside NAE. Spending patterns will not be altered much by rising or falling AEG% p.a. The cost of loan repayments will not leap up when interest rates rise by a percentage point or more.
Having all costs, payments, earnings, and values able to rise at a similar percentage rate compared to what they would otherwise be, is a condition to be met for creating a financially stable economy.
So ILS Mortgages can help to create financial stability / remove a significant amount of financial instability.
To find the entry value of 'C%' for a given total repayment period please visit Waghorn's Equations
OTHER LINKS
That will be done on another page of this website  as yet not written. But it has all been worked out and is waiting to be published. There are examples of what can be achieved on some linked pages. For example:
NEW FINANCIAL PRODUCTS RESULTING
and
There is some way to estimate the upper and lower limits of I% which concludes that I% always averages somewhere between 1% and 4% over the long term in order to create a limited rate of inflation.
This means that D% = 4% should be enough in most cases to prevent P% from having to leap upwards which is what happens with LP mortgages using variable rates of interest.
Here is why:
P% = C% + D% + I%
Let I% rise by a maximum of 4% and remain at that high level.
For P% and C% to be unaffected D% must fall by 4%
So a typical safe loan might be given by:
P% = 1.5% (repays in around 25 years) + 4% + 3% where I% = 3% (assumed) even if it is lower or higher by a little.
So P% Safe Entry Cost is given by:
P% = 1.5% + 4% + 3% = 8.5%
This is the entry cost used in almost all tests of this new ILS Model for Housing Finance.
A fairly stable entry cost of 8.5% consuming, say 30% of the earnings of a single borrower, we get a loan of 3.5 times annual earnings. It is assumed that lenders will select net earnings after deducting commitments like credit card payments and other loans...
Exactly how they apply this equation is up for discussion.
But clearly it is risky to lend a lot more and it is not necessary to lend a lot less. the value of P% is not a function of r% or of AEG%.
Property loans will have a value which rises with NAE. This meets the requirements given for a financially stable property sector which is also low in arrears.
The payments 'P' rise annually as fast as NAE rises less the scheduled reductions of D% p.a. But macroeconomically the lending sector as a whole comprises new and old borrowers so the amount of aggregate earnings devoted to mortgage repayments will tend to rise alongside NAE. Spending patterns will not be altered much by rising or falling AEG% p.a. The cost of loan repayments will not leap up when interest rates rise by a percentage point or more.
Having all costs, payments, earnings, and values able to rise at a similar percentage rate compared to what they would otherwise be, is a condition to be met for creating a financially stable economy.
So ILS Mortgages can help to create financial stability / remove a significant amount of financial instability.
To find the entry value of 'C%' for a given total repayment period please visit Waghorn's Equations
OTHER LINKS

The basic economics and my group's theory of the origins of financial instability, is given on the Home Page of the Main Blog, and is being written more fully as a NUMBER OF BOOK VOLUMES of which this mathematics will be a key part of the overall book.
Currently the title will be 'A tract on Financial Stability' or the short version will omit this and will be called 'A Short Tract on Financial Stability'.
Currently the title will be 'A tract on Financial Stability' or the short version will omit this and will be called 'A Short Tract on Financial Stability'.
There is this page on NEW FINANCIAL PRODUCTS RESULTING which is based upon this maths.
Some of the research done on past true rates of interest can be found on the three pages starting with this one. The third page explains why interest rates are distorted and currently low.
Section #1 of these volumes will be about financial stability in the savings and loans sector.
Sections #2 and #3 of the book are covered quite well in outline on www.fin24.com in the later essays. There is a guide to those essays here.
Sections #2 and #3 of the book are covered quite well in outline on www.fin24.com in the later essays. There is a guide to those essays here.
Section #2 deals with problems of money creation, including the cause of unstable interest rates, booms and busts resulting, and a suggested remedy. A lot of research is currently under way on this topic and is outlined, but this book probably leads the way.
Section #3 deals with currency price instability, and a suggested remedy.
This maths page is a part of Section #1 or it may be an Appendix to Section #1.
Various attempts have been made to write the opening pages of the book on this website  but they are all now out of date.
No comments:
Post a Comment
Please type your comment here
Note: Only a member of this blog may post a comment.