Mortgage for the rest of us.
Unless you’ve spent a lot of time researching mortgage, compound interest, & amortization schedules, there’s a good chance you’re like most people—not really sure how all of this works.
We’re here to help.
It can all be confusing—your rate is fixed at 4% but your last mortgage payment said you paid $1,500 in interest, and only $648 towards principal. That’d be the case on a $450,000 mortgage with a 4% fixed rate.
Those amounts won’t trade places for more than 21 years, at which point you’ll finally be paying $1,500 towards principal, and paying $638 in interest.
Your monthly payment will be $2,148 (including $375/mo for property taxes) for all 30 years. By the time you pay off that loan, you will have paid the $450,000 loan back—plus another $321,915 in interest. All told, you’ll have paid $906,915 to own that home.
Seems like, if you’re paying $2,148 per month, then 4% of that amount should be interest, right? About $86.
Think again—you’re not even close. Your 4% fixed rate becomes 72% over 30 years. (See our chart for Stated vs. Effective interest costs below to see what you’re actually paying in interest with your fixed rate.)
Stated vs. Effective Interest
“How is that possible? I thought I was getting a 4% fixed rate—I never would have signed up for a 72% rate!”
In other words: why is my stated interest rate so different than my effective interest rate? The answer is because of two things: Amortization, and Compounding Interest.
Amortizing a loan simply means you’re calculating each month’s payback according to a predetermined schedule that will include principal & interest (and taxes and insurance, if you’re escrowing).
Any mortgage calculator will let you input your loan amount, the interest rate, and the term (length of time you’d like to spread out the payments). You’ll be able to see how the monthly payments are calculated to stay consistent throughout the entire term. And you’ll notice the 8th wonder of the world (according to Albert Einstein) working against you: compound interest.
Compounding Interest means that instead of simply paying your interest rate multiplied by your loan amount once, or even each year, you’re multiplying those numbers each month. So month one on a $450,000 loan at 4% will cost you $1,500 in interest. Month two will cost $1,495.67.
Simple interest would mean you’re only paying 4% interest over the life of the loan—ie, $18,000 on a $450,000 loan. Instead, you’ll pay that in the first year.
Compound interest means that you’ll pay 4% of your loan balance amount every month, and since you’re barely lowering your principal each month in those first fifteen years—remember, most of your payment isn’t even touching your principal--the balance stays high, resulting in massive interest costs even though it’s a 4% fixed interest rate.
By the end of the second year, you will have paid nearly $36,000 in interest, and only $16,172 towards principal.
By the end of the third year, you will have paid $52,505 in interest, and less than $25,000 towards principal.
By the time you will have paid down $50,000 on that loan, you will have spent almost $100,000 in interest. That’ll take 70 months—just shy of 7 years.
Principal, Interest, & Escrow amounts over 1st seven years.
These are a few of the reasons why we don’t prioritize interest rates.
Rather, we scrutinize the actual interest costs.
Just because one loan has a lower rate than another doesn’t make it a better loan. Compare that 30 year fixed 4% mortgage to a 15 year fixed at 7%: In the latter, you’d save $46,481, despite the higher rate. Instead of paying 72% in total interest, you can get that down to 61%.
AIO clients often get their total interest paid down into the teens.
Our clients referred to in our introductory video who make $10,000/mo and only spend 65% each month will end up paying 19% total interest on their $450,000 loan by depositing their $50,000 and buying the margin down to 3% using the historical average interest rate of 5.535%. They’ll pay off their loan in 7.3 years and save over $230,000.
Comparing 19.7% total interest paid to 72% or 61% shows you this is a very simple decision.
“Did you know: the word “mortgage” literally means “death pledge,” meaning I’m paying this back on promise of my very life.”
Compare the first 5 years to the last 5:
In the first 4 years, you’ll pay $85,775 in interest and $43,000 towards principal.
In the last 5 years, you’ll pay $12,247 in interest and $118,408 towards principal.
