First of all, the entire financial engine in the United States has pulled the wool over the eyes of the American public.
If you, a typical consumer in the United States, were asked some of the basic things you should do in your financial life, you would respond as follows:
“Invest well. Buy real estate. And, save for retirement as early as possible.”
So, if you buy a home, what should you look for in good financing?
“Oh, definitely the lowest fixed rate that can be found.”
Well, this very thing is what you have been taught. So, why shouldn’t you believe it?
Probably one of the worse, if not the worst loan you can get is the standard amortized fixed rate loan marketed by your local banker.
Did you ever stop to think why the person profiting from your loan is telling you this is the loan for you?
This and the insurance industry are likely the largest legal robberies of our modern age. And we, like sheep, head to the slaughter with smiles on our faces.
This is what you get with an amortized loan.
1) You get to pay three or four times the value of the property.
2) You don’t start paying for the property until you have paid for the loan.
3) You get to pay them for doing this to you in fees.
Let’s look at a typical home purchase of a fairly nice home around $200,000.00 dollars.
Let’s put 10% down for our example. The average first home buyer will do this or less.
Down Payment: $20,000.00
Amount Financed: $180,000.00
Monthly Payment: $1,197.54
(Principal & Interest ONLY)
Since you are putting LESS than 20% down, you will need to pay PMI (Private Mortgage Insurance), which tends to be about $55 per month for every $100,000 financed (until you have paid off 20% of your loan). This could add $99.00 to your monthly payment.
Monthly Payment: $1,296.54
(Principal & Interest, and PMI)
Residential (or Property) Taxes are a little harder to figure out… In Massachusetts, the average residential tax rate seems to be around $14 per year for every $1,000 of your property’s assessed value.
Let’s say that your property’s assessed value is 85% of what you actually paid for it - $170,000.00. This would mean that your yearly residential taxes will be around $2,380.00 This could add $198.33 to your monthly payment.
TOTAL Monthly Payment: $1,494.88
(including PMI and residential tax)
Ok, let’s multiply $1,494.88 for 360 payments across the 30 year loan.
Well, we have actually paid $538,156.80 for the loan. Let’s add the $20,000 we put down, and we have paid 558,156.80 for the property.
So, the cost of the loan was $358,156.80, and we end up paying well over two and a half times the value of the property.
If that isn’t bad enough for you, let’s get to the really silly part. The amortized loan is absolutely the dumbest loan you could ever get.
An amortized note takes the amount of the loan, figures the interest, and then slides most all the interest to the front. In other words, you won’t be paying more than 50% of your payment on the principal until well over half the loan. The banker will get around 97% of your payment amount at first and the bulk of your payment for the first 8 to 10 years. So, after 8 years, you will still owe over 80% of your homes value. But, the banker will have 80% of his money. To be honest, you have a better deal than this with a high rate credit card!!
But what about the tax incentives? Ok, here’s what that gets you. For giving away $12,000.00 dollars of your money, you get to deduct a percentage of it from your income. So, maybe, you’ll PAY $2000.00 less in taxes for the year.
So, if you think that is good, I’ll take $12,000 of your money, and give you $2000.00 back all day long!
But what about the investment? OK, here’s what that gets you. In a very good economy, a home’s value will increase, maybe, 10% in a year. To get a national average, you can figure 3% to 5%. You can get lucky with this in a hot area. Let’s just look at what is typical. So, your home is worth $170,000.00. It will increase in value around $8,500.00 per year.
Here is where everything gets really interesting. The average family in the United States moves somewhere between 3 to 7 years. If we use the upper figure, then we will gain around $60,000.00 in the value of our home. So, what does everyone say?
We say we paid $200,000.00 for our home, and sold it for $260,000.00. That was a really good investment.
We fail to account for the $84,000.00 we paid in interest across those years. This yields a net loss of $24,000.00. Minus the huge tax incentive of $14,000.00. Wow!! We only lost $10,000.00 on this house!! Now, there’s a deal! There’s the American Dream.
The fact is, if you are going to get an amortized loan and be stupid, then at least get one with an adjustable rate. What?!?
That’s right, an adjustable rate will be the lowest right now. And right now is when you are paying all the interest. Then, you want terms with a cap. Like a 5 point cap and 1 point gain max per year.
The MOST important part of any kind of loan is the terms of the loan.
You want a simple interest loan. This kind of loan in NOT amortized, so the payment and interest go down every month.
Finally, if you are smart with your money, and can invest it, the absolute best way to buy a house is a simple interest, interest ONLY loan. How is that best, seeing you never pay the principle?
Lets take our $200,000.00 dollar house. Simple interest with a term of 7 years will get us a better interest rate. We should be able to get 5% to 6%. But we can’t afford to pay it off in 7 years? Remember, we’re moving in 7 years!! We’ll never pay it off either way. If we don’t move, we’ll simply renegotiate our terms. Our interest only payment will be a little over $900 a month plus our PMI and taxes, bringing our monthly payment to around $1,164 per month. That’s a net savings of over $330.88 per month.
Now we didn’t use our $20,000 for a down payment. We invested our $20,000.00 in a cd yielding 4%. We earn roughly $5,600.00 on it in the 7 years. Next, We also claim the same tax claim. So, we keep the same $14,000.00 of our money as well. Finally, we ONLY pay interest. Remember? So we now have 330.00 per month to invest, since we aren’t paying the principle. With NO interest we would have $27793.92 at the end of 7 years just in the difference.
Now, we sell the house for the same $260,000.00. We add the $27,793.92 difference. We add the $5,600.00 from our $20,000 investment. PLUS, yes PLUS. Now we still have the $20,000.00 we started with. So, we add that to the difference! This time we sell the house, and end up with 313,393.00. WOW, now that’s a REAL difference! Now when we subtract the $84,000 in interest (actually less with these terms) we really did have an investment.
Don’t you dare get an amortized loan.
You don’t believe me?
Paste this: “interest only mortgage” in the search at the top or bottom of this page and check it out. You’ll see links and ads for $150,000.00 mortgages that cost only $612.00 per month. I even saw one claiming $381.00 per month.
Now, if you don’t use your savings well, then this won’t help you as much. It will only get you the monthly savings. But, if you save well, this lets you use the money from a house that you will never own. And guess what? You don’t ever want to own it. You want its money to work for you!