A Mortgage Tale





Before I get into this tale, I need to write about a home purchase in general.  Also, some might not know what a mortgage is.  Let me explain.  A mortgage is a loan.  You sign a contract that commits you to pay a monthly amount at a stated interest rate until you have paid it all off.  When you have a zero balance, then you own your home.  Until then, you do not.  So, 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 you should throw out all the other golden rules because all that matters is where you buy.  If you don’t, you can get in a lot of trouble.  There is more to buying a home than a great location, however.  My phrase would be “location, location, affordability and terms.”  This means the wise homebuyer avoids a great location they can’t afford as well as a great location offered at an inflated price.  The recent and someday-to-be-repeated mass destruction of wealth associated with housing in the United States and other countries is due to homebuyers buying in 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 five years.  If you move prior to a five-year period, you might lose money on your home purchase, so I only advise people to buy a home if they have stability.  Furthermore, I advise them to buy a home in a good public school district, if not for your children, for resale value.  Homes in good school districts have fewer surprises when it’s time to sell.

Let’s look at the term afford (or affordability).  There is another golden rule.  It isn’t a good one, so avoid it.  It advises the buyer to “get the most expensive house you can afford.”  I wonder, who made up this rule?  Do you think it was a real estate agent?  Sure, real estate agents stand to make more money if you spend more, but they would never do something that’s self-serving, would they?  I bet they would.  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 two times the amount I was requesting.  What was wrong with me, he wondered?  Why wasn’t I buying a bigger house?  What was wrong was that I was at my comfort level.  I didn’t want to have an exorbitant monthly mortgage, since there are hidden costs associated with home ownership.  I call these hidden costs “living,” and they are often something brokers and mortgage bankers conveniently overlook.  If you have ever heard the expression “house poor,” you know exactly what I mean.  It means your house is taking all of your income.  Don’t let this happen.  I estimate the cost of home ownership is 30% above the cost of a rental equivalent.  Nevertheless, we need a more concrete definition of affordability other than just comfort level.  What is a good one?

Here’s what I think.  Assuming you do not want to be “house poor,” 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 don’t plan to move for at least five years.  I throw in the five-year caveat because most people who lose money on home sales are those who live in houses for a short period.  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.  Do you have any guesses?  Let’s analyze a typical home purchase and see what an extra 10% does for you every month?

Tom and Judy bought a house for $200,000, and after a $40,000 initial deposit or down payment, they got a $160,000 loan.  The interest rate was 6.40% 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 fewer 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 and 2/3 years.  By month 280, Tom and Judy will have paid an extra $28,000.  This means 280 months times $100 per month, but they will have saved $80,000 (or 80 months times $1000 per month).  The payoff is $285 for every $100 they sent in over their regular payment.  This is a powerful savings tool and one that people should consider doing when they purchase a home.  Every time you make an additional payment or a payment above and beyond what is required, tell yourself that for every $100 you are getting $285 back.  It may not be exact for you, but it is a powerful visual.  It is also a good investment.

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