This is a good example why one should understand compound interest. Through in a payment schedule and amortization as well.
The bank is giving you $X to buy the house. You’re paying off a piece of it each month (your mortgage payment). Part of that goes to the interest on the loan, the rest goes to principal. The interest each month is based upon on the remaining principal. That means your payment starts off being mostly interest and gradually becomes mostly paying off principal.
You could say, “But I can just save the full price and then buy the house with no interest!”. Sure you could. But you’re forgetting that you’re living in the house (or renting it out...) while you’re paying it off.
"Part of that goes to the interest on the loan, the rest goes to principal."
That's only one kind of mortgage though - for a while there were mortgages available in the UK where you only payed the interest on the principal but you also payed into a separate saving scheme with the idea that when the latter matured it would pay off the former.
No idea if these are still available, but for a while in the early 1990s you used to get a very hard sell on them - we had one for a five years or so. In reality they are a terrible idea as you are paying interest on a non-decreasing principal which is a shockingly bad idea and then there is the risk of the saving scheme performance as well.
Edit: Of course you got a hard sell on them as they were clearly a terrible idea from the borrowers perspective but were far more profitable than a normal mortgage for the lender.
These are still around and pushed pretty heavily, but they are primarily for "Buy to Let" mortgages in my research. And offer an astounding TERRIBLE rate on top of the astoundingly terrible concept.
That said, the interest is a great write off for a landlord, especially if they are personally the originator of the loan to their holding company.
Just seems like a massive scam thats become the norm. You're paying off interest on the first month, as if you've already had the money for 20 years. They take liberties from day one.
Let's break this down with a simple example:
You get a 30yr mortgage for $100,000 at 5%
If you paid $0 on principal your first year, the interest would be $100,000x0.05=$5000
Make it monthly: $5000/12=$416.67 rounded up to $417
On an amortization schedule, the fixed payment is calculated at $537, with $120 going to principal and $417 going to interest on your first payment. Exactly what you would expect to pay. The interest isn't front loaded, it's just the actual accrued interest of what you have borrowed.
When you pay the $120 in principal on your first payment, your debt reduces to $99,880. $99,880x0.05/12=$416 rounded. Therefore, your next payment, still at the fixed rate of $537 is now paying $121 in principal, and $416 in interest.
In short, when you have a large debt, you pay larger interest, when you have a smaller debt, you pay smaller interest. This isn't exploitation, just mathematics.
I conclude that they should just work out the total repayable and be honest and say this is a 70% mortgage. not claim it's 2% but just keep re applying that 2% every month or week or day as they see fit.
Most of the time, the total interest paid is included in the amortization plan. It's also easy to figure out. Using my example, the exact payment was $536.82.
$536.82x12x30=$193,255.20
Total($193,255.20)-Principal($100,000)=TotalInterest($93,255.20) give or take a dollar.
And so according to your desire, you'd want them to say it is a 93% mortgage.
The reason they don't is that interest rates and compounding are typically done annually. You also have the ability to make extra payments sometimes, which can pay it down faster. The faster you pay the debt, the less interest you pay.
For instance, if you win the lotto, receive a life insurance payout, or inheritance, etc and pay off the loan within the first year, it's no longer a 93% mortgage but a 5% one.
To me, it makes more sense to say, you owe $100,000 your first year, or $98,398 your second year, and that you'll be paying 5% interest over that year.
Hey, kudos to you for admitting this! I mean that seriously. There are very few folks who actually try to learn and understand things: it appears that you're one of them.
But that depends entirely upon how long you take to repay it. If you pay the loan aggressively up front, you pay less; if you make minimum payments for as long as possible, you pay more.
It’s 5% per year because you are charged interest on some schedule based on how much you have paid off. 5% is a rate, 93% is a total amount and it only applies if you pay the whole mortgage off at exactly the prescribed rate. Many banks’ mortgage calculators will show you the total amount paid anyway so it’s not like they’re hiding it.
Your point seems to be basically that because you can’t do the maths, the mortgage is misleading. That is maybe a fair argument in some cases with financial products. Investment banks are notorious for obscuring the true cost of deals with complicated maths. However this doesn’t seem like a case of that. If the interest rate is 5% APR and you are free to pay it off as fast or as slowly as you like within some bounds, for example, it is absolutely essential that you understand what a 5% rate means to know how the mortgage works.
edit: not to mention that 5% is already a contrived figure not representative of how the interest is actually applied, designed to make it easier for you to understand what you’re charged. Your interest is probably calculated monthly or daily, not yearly. They could present you a nice hypothetical yearly figure, or a nice just-as-hypothetical 93% three-year figure. What’s the difference? Neither of them are real. Your interest is charged monthly, so they’re equally fake and misleading.
Why should there be no charge for borrrowing the money for 20 years? That doesn’t make sense, you have had the money for 1 month when you make the first payment, and so you are charged for it.
I don't understand this. You have negotiated to pay a fixed payment per month so why does it matter whether the money is paying off interest or the principal first? The bank didn't force you to get the loan.
It matters to the bank. Also, the interest can be written off against income taxes, which helps people more in practical money left over to use when they are earlier in the amortization, and probably their career.
Bank didn't force me. Society has made it virtually impossible for me to own a property without one. Which seems unfair when a lot of people got their property 35 years before I was born for the equivelant of 2 years salary.
The bank is giving you $X to buy the house. You’re paying off a piece of it each month (your mortgage payment). Part of that goes to the interest on the loan, the rest goes to principal. The interest each month is based upon on the remaining principal. That means your payment starts off being mostly interest and gradually becomes mostly paying off principal.
You could say, “But I can just save the full price and then buy the house with no interest!”. Sure you could. But you’re forgetting that you’re living in the house (or renting it out...) while you’re paying it off.