If you are anything like me, you most likely find yourself at the mailbox every day trying to maintain some slight glimmer of hope that maybe, just maybe today will be different and there will actually be some mail worth getting awaiting you. And again, if you are like me, those hopes are usually extinguished by bills and junk mail. But if you want to add a bit of interest to this daily drudgery, it is worth considering for a small moment the motives and incentives companies have for killing so many trees in order to push this junk mail into your mailbox.
For me personally, second to credit card applications, I see junk mail soliciting for mortgage refinances the most. In fact, in any given week the refinance spam may actually trump the credit card junk. Ever stop to think why banks push so hard to get you to bite?
I used to think refinancing was all about the fee you pay to refinance. Then there is the whole buying and selling mortgages. Lots of money in that, right? But I recently had a new thought – the “younger” the mortgage, the more the monthly payment goes towards interest. The more mature the mortgage, the more the monthly payment goes towards the principal. I thought I would do some simple math and look at the progression.
Here come the numbers: The two tables below show typical $200,000 30 year mortgages at either 4% or 6% interest. They show, in 5 year increments, how much money goes to paying down the principal, and how much goes to pay the banks in the form of interest. It’s easy to see that the further into a mortgage you get, the more money hits the principal instead of disappearing in interest payments.
| $200,000 30 year loan at 4% | ||||
| Year | monthly pmt | $ to interest | % to interest | % to principal |
| 1 | $ 954 | $ 666 | 70% | 30% |
| 5 | $ 954 | $ 604 | 63% | 37% |
| 10 | $ 954 | $ 526 | 55% | 45% |
| 15 | $ 954 | $ 432 | 45% | 55% |
| 20 | $ 954 | $ 316 | 33% | 67% |
| 25 | $ 954 | $ 175 | 18% | 82% |
| 30 | $ 954 | $ 9 | 1% | 99% |
| $200,000 30 year loan at 6% | ||||
| Year | monthly pmt | $ to interest | % to interest | % to principal |
| 1 | $ 1,199 | $ 1,000 | 83% | 17% |
| 5 | $ 1,199 | $ 931 | 78% | 22% |
| 10 | $ 1,199 | $ 838 | 70% | 30% |
| 15 | $ 1,199 | $ 712 | 59% | 41% |
| 20 | $ 1,199 | $ 543 | 45% | 55% |
| 25 | $ 1,199 | $ 315 | 26% | 74% |
| 30 | $ 1,199 | $ 10 | 1% | 99% |
Table 1 & 2: Table 1 shows the payments, in 5 year increments, of a conventional $200,000 30 year loan at 4% interest, and how much money goes towards the principal versus to paying interest. Table 2 gives the same information for a loan at 6% interest.
For the 4$ loan, in the first 5 years, around 70% of monthly payments goes to interest. For a 6% loan over 80% goes to interest! For the last 5 years of the 4% loan, only 18% or less goes to interest, while at 6% less than 26% goes to interest. It’s plain to see that, during the early stages of a mortgage, much of your payments go up in smoke. Might this prove to be incentive enough for banks to push for consumers to refinance? The first 10 years of paying on a mortgage are FAR more profitable for a bank than the last 10 years. If consumers begin new loans every 10 years instead of sticking with the original one, banks have a lot to gain!
This is very important information to anyone considering renting versus selling a property. If a person has paid on a home for 10 years, sells and begins a new mortgage, they are hitting the reset button on their payments, relegating over 70% of the payment to interest. If that same person could rent rather than sell the property, they are 10 years into the mortgage and paying far more (around 15 to 20% more) towards their principal, essentially saving several hundred dollars a month in real money that goes to paying down debt rather than paying a bank. For the 4% loan, the amount of money made in 5 years by nor resetting a mortgage is around $8,000!
Rather than selling and cashing out (hopefully) with a small amount of equity after 10 years, by renting and paying down the mortgage, in 10 more years, the equity built will grow substantially. Property appreciation or depreciation aside, after 10 years on a $200,000 6% loan, the owner would have about $33,000 of equity. After 20 years, that number nearly triples to over $92,000 equity. Of course, in 10 more years the property is paid off. And that’s when things get really good.
Information worth knowing, especially when trying to make a decision between selling and renting.
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