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Calculate Mortgage Interest Rates To Find The Truth In Your Payment!
I have been in the real estate industry for 25 years and currently hold a broker’s license in the state of Illinois. The subject I am going to talk about is a subject on which I have a lot of experience.
and one that I am definitely qualified for. The two biggest questions I have found and all my buyer clients have always had are one: what is the lowest price I can pay for this property and two: what is the best interest rate that I can to obtain? Of course, I’m talking about customers who don’t pay cash and need to get a mortgage, which has been the case for me, pretty much all of them. Let’s talk about mortgage interest rates and what they really are in reality what one is actually paying for this property and the interest percentage on all mortgage payments made.
This morning I went online and checked with one of the largest lenders in our country to see what the best mortgage interest rate they were offering was. Obviously the best rates are reserved only for those with the highest and most impeccable credit. Lenders always want to limit the risk for themselves. They will reward the best customers with the best rates. I’m not going to go through all the other factors that lenders use to qualify applicants. Let’s just assume one is qualified in the example I’m about to give for a $200,000 loan. One has the required down payment and falls into the correct debt to income ratio.
I found that I was offered today a rate of 3.75% fixed for 30 years. Fixed means the rate and monthly payment never change and are spread over 30 years or 360 months. That’s 360 payments. The second best rate I found was 3.25% fixed for 15 years. In the same way but for 180 months or 180 payments or 15 years. These rates are very low and seem very attractive. They sound good. Most people would jump on either of these mortgage rate plans. Homebuyers might even pay a fee or so-called points to qualify for one of these pricing plans! However, they are really not what they seem! Let me break down these two excellent, by historical standards, mortgage interest rate plans to honestly show what they really stand for.
Let’s talk about a $200,000 loan at 3.25% fixed for 30 years. I ran what is called an amortization plan. This is what the banking and mortgage industry uses to calculate the monthly payment and give a breakdown of how much money applies to interest and how much applies to principal, the one one borrowed originally. Here is the breakdown. The monthly payment on this loan will be $926.23. Now, I don’t include any other additions to this payment, such as property taxes or insurance.
I will only show what the actual distribution of interest and principal is. Notice I say interest and principal, not the other way around. The first monthly payment breaks down as follows: $625 is applied to interest and $301.23 is applied to principal or loan reduction. Now hear is the simple mathematical equation that one can use to calculate the percentage of interest that is paid in that 1st monthly payment. Just take the interest portion of $625 and divide that number by the actual dollar amount that came out of his checking account, or out of pocket, I like to say, and that’s what one will find. $625 divided by $926.23 equals 0.674 or 67%. Yes 67% interest!
Now let’s look at the totals after the first year. Twelve installments of $926.23 equals a total of $11,115
dollars paid. The total interest paid on this amount is $7,437.21. Divide the interest by the total paid to determine the percentage and that figure is 0.67 or 67% interest! Wow, where did the 3.25% go? Now let’s look at some totals over the years. After five years, we will have paid a total of $55,574 in mortgage payments. Of this figure, $35,635 is applied to interest. Divide $35,635 by $55,571 and the number is 0.64 or 64%. Yes, 64% is the actual average interest rate paid on that $200,000 loan at that excellent illusionary rate of 3.25%. If one looks at the ten year totals, one will find that the actual interest rate paid is 61%. The rate gradually decreases over the years.
If we had to pay regularly over 30 years, the average interest rate would be 40% and far from this most excellent rate, reserved only for the best customers, 3.25%.
This is what I call the magic banking effect of compound numbers. The truth is that the only time you would actually pay 3.75% or less is if that original $200,000 loan was paid off at the end of the first year or sooner and not with another mortgage. . Few do this.
Now let’s look at that same $200,000 loan at an excellent rate of 3.25% fixed for 15 years. The first month’s payment is $1,405.35. It is principal and interest only. Notice that this time I said the reverse of what I said about the 30-year rate. Of that figure, $541.67 is applied to interest and most of the payment is actually applied to principal. Now consider the real interest rate. The interest of $541.67 divided by the payment of $1,405.35 equals 0.385 or 38.5% interest. Much better than the 30 year old program. But once again far from this illusory rate of 3.25%. After five years, the total payments are $84,321 and the total interest paid on those payments will be $28,135. Divide the interest paid by the total paid to get the true interest rate of 0.33 or 33%. After ten years, the total interest paid is 27.5%. Continue with this plan for a total of fifteen years and the actual interest rate paid is 21%. A much better rate than the thirty-year plan. But still far from this illusory rate of 3.25%. More banking magic, in their favor of course.
So in summary, while payments of $926 or $1,405 on a $200,000 mortgage may be quite affordable for many, the truth is that the interest rate, or interest rate carrot for so to speak, is never really what one has been led to believe. ! It is true however that the lower the carrot rate or deception rate, the lower the actual real interest rate will be. I ran this example at a rate of 5.5% and found an effective interest rate of 80% after the first year of a 30 year program! If one has the ability to pay cash for a property, it can be easy to see by my examples here how that cash can actually give a return on their money of 21% to 67% over the rate program. mortgage interest, using the reverse reasoning!
I hope I have shed some light and clarity on how to calculate mortgage interest rates and the truth behind them. Anyone can find an amortization chart on the internet or just ask your real estate agent or banker for a detailed chart. Remember that the truth will always give you more power once you decide to see it. What you do and the actions you take are your choice. Another thing that I hope can be seen here is that the answer to the first question of what is the lowest this property will go for is actually figured in the answer to the second question of the interest rate mortgage. Be empowered or be mastered in today’s world! Sincerely….Sam Assil
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