Understanding Home Loans ~ Amortization
Is it possible that the old standard of calculating home loans is killing the real estate market and our economy in general? Maybe it is time to think about a new way of calculating home loan payments.
Amortized loans were first introduced by the Federal Government during the great depression (not sure what was so great about it) because people were losing their homes due to their inability to pay the balloon payment that was common at that time. Although we would like to think the Fed created amortized loans to get more money out of us, in actuality, they were trying to help people keep their homes. This was a time when homes were predominately owned by the wealthy (about 60% of the population rented their residence). Things were tough and even the wealthy struggled to pay their mortgages.
Visit my Website at JeffreyHogueRealtor.com and click HERE for a complete reference of the 1932 and 1934 Mortgage Act.
Mortgage loans are a good thing. They provide us the opportunity to purchase and occupy a home before we have all the funds to do so. This opportunity does come at a price. That price is known as the amortized payment schedule. This means each month part your payment goes towards both the principal balance and interest payment (cost of the loan) until the loan is paid in full.
What I found oddly interesting while researching this subject was that the term ‘amortizing a debt' was derived from the French term ‘amortir’, which is the act of providing death to something (like maybe your wallet).
Let’s review how your amortized mortgage payment is calculated…
The payment of an amortized loan is calculated by adding the total loan amount (principal) to the total interest that will be paid over the life of the loan and then dividing by the total months (30 years x 12 = 360 months).
Let’s use the following example: $100,000 mortgage loan (the principal amount), 4% interest, and a 30-year term. Now we need to figure out the total interest. The formula is (Interest = Principal x Rate x Time). The easiest way to calculate total interest is to use an amortization table. Visit my website at JeffreyHogueRealtor.com and Click HERE to view an amortization table.
According to the amortization table, the total interest you’ll pay on the loan following the full 30-year term is $71,869.51. That is quite a chunk. Now to calculate the monthly payment:
Total Principal ($100,000) + Total Interest ($71,869.51) = $171,869.51 / Total Number of Payments (360) = $477.42. This is known as the P&I part of the mortgage payment (principal & interest).
Here’s the catch, the majority of your interest is paid up front. You see, each payment is calculated based on the outstanding loan principal. Your first month’s payment is $477.42 with $333.33 going to interest and $144.09 paying down your principal. That means the following month your interest will be calculated off your new principal of $99,855.92 ($100,000 – $144.09). Ouch!
My idea… Let’s say you agree to pay back the total amount of $171, 869.51 over 30 years. $238.71 (half of the $477.42) would go towards the principal and the same amount towards interest (50% / 50%). Within 7 years your principal balance would be $79,948.36. Using the amortization schedule of 1932, after 7 years your principal balance would be $86,059.47. Using my plan you would have $6,111.11 more equity in your home!
We have become a transient society and need a mortgage plan that reflects the times we live in. On average we move every 7 years. The reason many people do not move is that they do not have enough equity in their home. This may be because there is too much money going to the interest payment up front and not enough towards the principal balance.
We need a new plan for home loans. Happy Memorial Day / Say thank you to a Veteran!
Knowledge is power!
Jeffrey C. Hogue