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Before I get into this tale I need to write about a home purchase in general. Also, since many don’t know what a mortgage is let me explain. A mortgage is a loan you commit to repay on a monthly basis until it is paid in full. When you hear the word mortgage think loan or debt.
There are so many golden rules in real estate that I can’t repeat them all. One I generally agree with is the phrase location, location, location. The phrase means that you should throw out all the other golden rules because all that matters is where you buy. If you do you can get in a lot of trouble. There is more to buying a home than a great location. My phrase would be location, location, affordability and terms. By this I mean that the wise investor avoids a great location they can’t afford as well as a great location offered at an inflated price. The recent mass destruction of wealth in the United States and other countries that surrounds housing is due to unwise investors buying great locations they couldn’t afford or paying inflated prices or both. You need to avoid this throughout your life. Location isn’t everything but it is the first thing.
What should people do when they buy a house? They should find a good location, and pay an under the fair market value price for it, under mortgage terms they can afford, with the intention of staying in the same location for at least 5 years. Let’s look at the term afford or affordability. There is another golden rule. It advises the buyer to “Get the most expensive house they can afford.” I wonder who made up this rule? Do you think it was the real estate agent that would stand to make a higher commission if they sold you a more expensive house? The key word in the phrase is the word afford. The last house I bought the mortgage broker almost laughed at me when I told him my mortgage amount request. He said that I qualified for more than 2 times the amount I was requesting. What was wrong with me he wondered? Why wasn’t I buying a bigger house? What was wrong is that I was at my comfort level. I didn’t want to have an exorbitant monthly mortgage. But we need a more concrete definition of affordability other than just comfort level. What is a good one?
I think you can afford to buy a house if you can make 10% above the monthly payments on your house at the prevailing interest rate on a 30 year fixed loan or mortgage and you plan on staying at least 5 years. I throw in the 5-year caveat because most people that lose money on home sales are those that live in houses for short periods of time. Let’s get to the tale.
This tale deals with what I call “The Payoff.” It shows you how much bang you can get for your buck by making a 10% extra payment every month. If your mortgage is $1,000 and you pay $1,100 instead how much do you save in interest? In other words, what’s this extra $100 worth to you? The answer is surprising. Any guesses? Let’s look at a typical example of a home purchase and what an extra 10% does for you every month?
Tom and Judy bought a house for $200,000 and after a $40,000 down payment they got a $160,000 loan. The interest rate was 6.40% and it was for 30 years. Their monthly mortgage payment was $1,000 per month. What happens if they pay an extra 10% or $100 every month? They will own their home in about 80 less months than the 360 months under the terms of a normal 30-year mortgage. This means not having to pay any mortgage payment for 80 months or 6 2/3 years. By month 280, Tom and Judy will have paid $28,000, 280 months times $100 per month, but they will save $80,000 or 80 months times $1000 per month. The payoff is $285 for every $100 they sent extra.
This is a powerful savings tool and one that people should consider doing when they purchase a home. Every time you send a little extra in just tell yourself that for every $100 you are getting $285 back. This is a powerful visual.
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Hi Carlos,
I think your Maths might be a bit squiffy here?
Of course paying off an extra 10% will reduce the mortgage, but I think when you totally up the 280 weeks, you should have multiplied it by $1000 (a month), not $100.
This will lead to every $100 extra leading to a saving of $80,000/$280,000 (= .286).
As a percentage this is still great though ($28.6 for every $100)
s.
Steve,
I think for what I am trying to say, my math is correct, though you may be right. What my tale says is that by paying an extra $100 per month you avoid paying $1000 per month for 80 months and this is an $80,000 savings. It only cost you $28,000 to save $80,000. I don’t like getting into other more complex calculations such as the time value of money because it confuses people. The point of the tale is that if you can pay a little extra it goes a long way and that being able to pay extra means you can afford the mortgage. Thanks for your comments. I am glad you are reading.
Carlos
This is ok, but if you can afford it, get a 30yr mortgage and pay it off in 15yrs is better. Any savings over a 30 year mortgage is unrealistic savings because I doubt many people remain in the same house for 30 years.
Don’t get a 15yr Mortgage because when financial problems occur having a 15 yr Mortgage payment per month might be difficult to make. Having a 30 yr Mortgage Payment is much easier. just pay it off over 15 years. Of course this requires discipline, which most people don’t have.