Monthly payment goes mostly towards interest?!

shatzileh

Tue, Feb 16 2016, 1:30 pm

Just to point out - it's not "a scam." Interest is charged based on how much of the principal you still owe. Naturally, at the beginning of the loan, when you have paid down the least principal, the interest is at it's highest.

Loans are amortized, which means you pay equal amounts every month. That first month, you owe a certain amount of interest based on how much money you owe the bank; the difference between your mortgage payment and the amount of interest you owe is how much principal you're paying. You can pay down more principal if you want.

You can check out an amortization schedule online. Some have very nice graphs where you can see that the amount of principal you pay down each month increases as the interest decreases. Again, this is because you owe the bank less money, and so owe them less interest, not because of any sort of scam.

shatzileh

Tue, Feb 16 2016, 2:18 pm

goforit - you'll end up saving possibly tens of thousands of dollars. You'll also end up paying less interest, which means less tax deductible dollars. It really depends on your financial situation, and what else you'd be doing with the money, how long you plan on living in the house, if you think your real estate will go up or down in value, on what your interest rate is, and probably lots of other stuff. If all else is equal, YES it's a great investment. But not all else is usually equal, and you'd have to evaluate it on your own, or have a financial professional help you out.

Disclaimer: I'm not a financial adviser or qualified to give any financial (or other?) advice. I'm just a fellow homeowner who knows her math Smile

shoshanim999

Tue, Feb 16 2016, 3:11 pm

shatzileh wrote:

I think if it's not an actual scam is pretty close to one and its at the very least abusive, unethical, and taking advantage. I realize that banks give the amortization schedule to the borrower and it's plain to see what the payments will be during the loan, but it still doesn't justify the bank staggering the interest in a way that it's paid mostly in the beginning of the loan. How is it fair if I borrow 500k and my interest rate is around 5%, and my first monthly payment is $2500, that around $2000 will go towards interest and only $500 towards principle? Plz give me 1 reason why the interest isn't spread out equally over the loan. The only reason is that the bank wants to zap the borrower and collect almost all of the principle if the borrower pays back the loan early. The bank does this because they know they can get away with it because the typical borrower doesn't have the money to purchase a house and needs the loan. If they want to buy a house they have no choice but to agree to these "shady" terms. (Is shady better than scam?)

shatzileh

Tue, Feb 16 2016, 3:52 pm

shoshanim999 wrote:

How would it be fair for you to pay less money than you owe? If your loan is $500,000, you owe the bank that much money, and they're not giving you free money. 5% interest rate per year is .416% interest per month (that's .05/12). At the end of the month, you owe them interest on all $500,000 that you borrowed from them. $500,000 times .004167 is $2,083.33. The bank is not getting away with anything.

To pay back less than $2083.33 in interest during the first month means that you're not paying the bank what you owe them. At best, you'd then be owing them more money. You don't want to pay interest on interest you owe - that's starting down the path of compound interest and financial ruin.

busydev

Tue, Feb 16 2016, 4:02 pm

The bank isn't staggering interest and it isn't a scam. Right now you owe the bank 500k. One months interest at 5% APR is 2083.33

So if you pay the bank 2500 then 2083.33 goes to interest you currently owe and 416.67 goes towards your principal.

Next month you owe the bank 499584.33 (500k-416.67 you paid toward the principal). 5% interest for a month is 2081.60. So your payment of 2500 is 2081.60 in current interest and the remaining 418.40 goes to your principal.

Third month you owe the bank 499165.93. Current 5% interest is 2079.85 so 420.15 is principal payment.

Now let's jump ahead a bunch of years. You now owe your bank 200k out of your original loan. 5% is 833.33 that you CURRENTLY owe. So your 2500 payment is 1666.67 toward principal.

The bank is doing you a "favor" (OK also making money) by letting you pay a set amount each month instead of a set amount of principal PLUS the current interest.

shoshanim999

Tue, Feb 16 2016, 4:23 pm

I see what your saying but it still seems shady to me. If I lent you $1000 at 10% interest over 10 months (obviously hypothetical, and not considering halacha) you would reasonably assume that your paying $10 interest per month. So you'd be making ten $110 payments. Don't you think it would be unfair if the loan was made in a way where of your first payment of $110, only $10 went to principle and the other $100 went to interest? You'd ask why can't I just pay $110 each month and have the interest payments allocated equally? It would certainly benefit me, the lender, to have your interest paid in the beginning so that if you pay off the loan at the half way point I've already pocketed most of the interest. Doesn't seem fair to me.

shatzileh

Tue, Feb 16 2016, 7:28 pm

shoshanim999 wrote:

The loan you created here is structured differently than a mortgage, and is in fact to your disadvantage. You are making 10 payments of $110, all together paying $1100, which is $1000 in principal and $100 in interest.

If you used a loan structured like a mortgage, you would have monthly payments of $105.58, paying a total of $1,055.82, which is only $55.82 in interest.

Even though in your loan, you're paying $100 in principal in the first payment, while in the "mortgage" you're only paying $95.58, because you're always only paying a monthly interest rate on the amount left, instead of a yearly rate on the total original principal, you're saving money.

Keep in mind, if you WANT to pay a set amount of principal on your loan, you're welcome to do it. This will let you pay off your mortgage faster! But don't expect to be allowed to pay less money than you absolutely owe at any given time, which is interest times your outstanding loan.

Also keep in mind: Interest is NOT a fixed amount of money that has to be paid by the end of the loan. The banks don't "make you pay the interest in the beginning." They cannot "let you pay it at the end" or at any other time aside from /when you owe it/.

Amarante

Tue, Feb 16 2016, 7:52 pm

I won't add to the explanations regarding how mortgage payments are structured.

However, "equity" for most people is achieved by the home appreciating in the long term and not in a few years. It was only during the housing bubble that people assumed that housing prices would increase 10% or more each year.

Financial security from homeownership is because of a combination of factors

Your mortgage payments are fixed which means that you wind up with lower payments in a few years than rent. This can really be a significant factor because for many people.

Your interest and real estate taxes are fully deductible which is a HUGE benefit to most middle class people.

If you approach home ownership sensibly - I.e. don't constantly upgrade housing you will own your home free and clear in 20 years more or less which means that your housing expenses will be minimal which will enable you to save money if you are still working or have lower expenses if retired.

Your home at the end of 20 years will be an asset - one that you can sell or even get a reverse mortgage on. For most middle class people who approached home ownership prudently (I.e. paid off their mortgage/didn't refinance etc), it probably represents their single most valuable asset.

Home ownership doesn't build equity in the short term and should never be looked at in that manner. Between closing costs, broker commissions, moving expenses and miscellaneous costs, home ownership doesn't make sense unless you are planning to stay at least five years. If you are lucky and the market appreciated in your area, you might realize enough after costs for a downpayment on a second home.