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When purchasing realestate the mortgage for it can be one of the biggest expense to cover, of course we are talking about a conventional 15 or 30 year loan here. Those fancy loans of ARM and interest only are a different ball game and generally are not suited for the average person buying a property to live in as their primary home. If you are looking for that kind of information it is not here – sorry! We are not a big fan of those and they can get you in trouble if you don’t know what you are doing.
Conventional Loans
The working of this kind of loan is pretty simple. You borrow some money and agree to pay it back during a fixed time period (typically 15 or 30 years) for a fee (the interest). That is the basic idea!
Here is an example for us to consider and learn the basics.
| Loan Amount |
$200,000 |
| Interest |
6% |
| Term |
30 Years |
| Principal + Interest |
$1199.10 per month |
The process to come up with the monthly payment schedule is called amortization. Each month you end up paying a fixed amount of money (in this case $1199.10 per month). This amount includes:
- Principal - The money you pay toward original loan (in this case $200,000)
- Interest – The money you pay the bank for giving you the money
 The way these types of loan are set up to pay the bank’s money first. That is, in the beginning a larger portion of your payment covers the interest and less on the principal. However since the terms of the load are fixe (6% for 30 year in this example) each and every month you pay your mortgage you will pay less in interest and more in principal.
Basically you own more of your house as time goes on and owe the bank less. The chart here shows the breakdown on an annual basis. The principal and interest payment is about $14,389 dollars per year during the life of the loan. As you reach the end of the loan more is paid toward the principal amount you borrowed. The rising bar shows this point in the example; interest payments shrinks and principal increases.
By the way this is how you build equity in your home, your house hopefully appreciates in value and at the same time you are owning more of the house, that is money in your pocket. That is a sure way to shore up your personal finances. Just remember it takes time to do this. No quick money in this example.
Rule of Thumb
You own more of a property as more payments are made
Here is a question to think about and we will cover it in the next article, how much interest do you pay to the lender for borrowing this money?
Answer: Almost the same amount as your principal – ouch!
Are you working for the bank?
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