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??