I learned something the other day, the word ‘mortgage’ literally means ‘dead pledge’. It is a pledge to repay debt for the rest of your life.
Some might look at getting a loan for a house because they are told that the house prices have averaged a 20% profit per annum in the last decade and they would be happy to borrow $300,000 for $25,000 per year profit. Key point here is that the $25,000 per year profit that these houses are bringing in, aren’t worth anything to you UNLESS you are willing to actually sell the house.
Ok, so let’s do the working out. You would need a job that pays say $50000 a year, don’t spend ANY and you will have $300000 in 6 years, pretty simple math right?
But hang on, we have to eat, drink, clothe ourselves, perhaps pay rent and utility bills, buy Birthday and Christmas gifts, travel and pay taxes, that all costs money.
Here is the reality of loans, mortgages and also credit cards.
For example, did you know that after 7 years on a 25 year, $100,000 mortgage at 8% you would still owe $88,211.
You would have repaid $64,833 and yet only reduced your debt by $11,789.
Even more startling is if you crunch the amortised numbers, is that in the first year you will have repaid $7,953 but only reduced your principal by $1,309.
(principal being the actual loan.)
In a second year you only pay an extra $109 towards the principal …. great deal for the banks!
You are handing the bank $65,000 over the first 7 years, they take off less than $12,000 of your loan while pocketing more than $53,000 in interest for themselves.
The solution (aside from not getting a loan in the first place)
Reduce the term of the loan and increase the amount of the monthly repayment that goes toward the principal rather than the interest.
With a $100,000 loan, if you elect to pay it off over 15 years instead of 25 you will actually be paying less interest from year one – $7,870 instead of $7,953. It might only be a difference of $83, but that make a big difference.
Sure the monthly payments would be higher but you save almost $60,000 in extra interest incurred over a 25 year loan, you save $2,400 a year. Banks don’t like you to know this info as you are denying them extra money. If we all put this knowledge to good use next time we tackle the banks, perhaps they would start being a bit nicer to us?