The True Cost of a Mortgage

True Cost of a Mortgage

Becoming a Home Owner, it’s one of the biggest parts of the
American Dream. It has been said many times that this is the most important
investment you will ever make. It is also the biggest purchase most individuals
will ever make.

A lot can be said about purchasing a home. For some people
it’s the realization of a dream many years in the making. That might be due to
the fact that it took them many years to become financially stable enough to be
approved for a mortgage. For others it is the beginning of their “Adult” life.
Regardless of the reason, it is a very exciting time. For others it is a very
nerve-racking time. When you think about it, you are committing the next 30
years to a payment without knowing what will happen over the next 30 years.

If you are reading this you probably fall into 1 of 2
categories, you are currently a Homeowner, or you will become one in the
future. It doesn’t matter which category you are in because I want to teach you
something the Bank never will. Something that most of the folks that work there
don’t even know. If they do know, they have no incentive to tell you this. And
that is “What is the True Cost of a Mortgage.”

Sure, when you signed all 973,298,672,093,609,217,601,732
pages (there aren’t that many, but it feels like it) that are part of the
mortgage document they told you what your APR is and your monthly payment, but
likely nothing else. That is because they either can’t explain it, or they
don’t want you to know.

In this article we will dig into what it really costs to buy
a home.

The first part of every mortgage is one of the numbers that
you will know and that is what’s called the Principal. This is the total amount
of money you are borrowing to purchase the home. Typically, this amount will
include additional things such as Closing Costs, Loan Origination Fees and
various other things that can be tacked onto a mortgage.

The second part is the Interest rate. Interest rates can
either be variable or fixed. We will not discuss the pro vs. con between these
types in this blog. We will focus on the actual cost of the loan.

Both of these parts will determine what the monthly payment
is. In this example we will use a $200,000 mortgage for 30 years, without any
extra charges, and a 5% fixed interest rate. Also, all of our numbers come from
www.amortization-calc.com.

Once you go to that site you can simply plug in your numbers
and it will tell you what your Amortization Schedule looks like. The first
thing you will likely notice is the monthly payment, which is $1,074 per month.
The 2nd thing that jumps off the page is the Total of 360 payments is $386,512.
Based on some very simple math it means I am paying $186,512 in interest over
those 30 years. Think about that, you will pay almost as much in Interest for
your home as the purchase price. This just seems outrageous. What makes it even
worse is that the bank makes you jump through all of their silly hoops for the privilege of paying them $186,512 in
profit!!

Unfortunately, the ugly math isn’t over yet. As you scroll
down the page it will show the actual breakdown of the Amortization Schedule.
On the left of the diagram is the Month that a payment will be made. The next
column to the right shows how much of my monthly payment goes to Interest,
followed by the amount that goes to Principal, and then what is the remaining
balance on the Mortgage. This is the part that will make you feel slightly
nauseous.

In the very first month my $1,074 gets divided between
Interest and Principal. $833 goes to Interest, while only $240 does to
Principal. That means that over 77% of my payment went straight to the bank’s
profits, while only 23% actually goes to pay down the loan amount. The reason
for this is very simple, by keeping the balance of the mortgage higher they can
charge more interest. The good news though is that it gets better over time.

Now we are 3 years into the mortgage and we have dutifully
paid $38,664 into the bank. Surely, they have rewarded you by applying most of
that money to the Principal, right?? Well…. Kind of. The balance of your
mortgage now stands at $190,408. So that means that of the $38,664 you have
sent them only $9,592 has benefitted you. The rest went to the bank. Alright,
but it’s only obvious that more of my monthly payment is going toward the
Principal, isn’t it?? Slightly. By now $795 is going to the bank in Interest
payments and $279 is going to the principal. 74% of your money is still going
to the bank’s profits. Keep your chin up though, it will continue to get
better.

Let’s fast forward to the 10-year mark. By now you have
faithfully paid the bank a total of $128,880. There is absolutely no way that
your loyalty hasn’t been rewarded. Surely the tide has turned and you are on
the better side of this deal, aren’t you?? Sadly, no. Your Balance stands at
$162,288, Only $38,722 has been applied to your Mortgage. That means you have
paid the bank $90,158 over the last 10 years. What’s even worse is that $678 is
still going to the bank each month in Interest, only $396 is being applied to
the balance. Each month 63% of your payment disappears to the bank.

How about we look 15 years down the road. By now, you are
probably feeling pretty terrible. But there is now light at the end of the
tunnel, we hope. Wrong again. Your running total now stands at $193,320 in
total payments. Your balance is at $135,260, so only $64,740 has been credited
to you. The Bank has profited a running total of $128,580. That is depressing. Just
to finish out the math, $566 is going to Interest and $508 is going to
Principal each month. Even after 15 years they are still getting 53% of your
money each month.

According to the Amortization schedule it isn’t until you
are in the 17th year that the numbers begin to tilt in your favor.

Even after 20 years you are still paying 40% each month to
the bank. At this point you have paid $257,760 to the Bank and your Balance is
still over half of the original amount, $100,573 to be exact. The bank has now
recouped over $157,000 from you. This really is a great deal for them.

But not to worry, along the way they have likely offered you
a chance to Refinance your Mortgage. You were probably able to cut your monthly
payment down by $100 or $150 a month. It sounded like a good deal and it was……
for them. Because they got to start you all the way back at the 30-year mark,
where 77% of your payment goes straight to them.

But, it sounded like a good deal, right??

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