How does a Mortgage work? - Newbie

6 Replies

Hi All! Can someone please clarify this for me? 

Let's say the purchase price of a house is 200,000. I put 20% down that's $40,000 so my loan would be for $160,000.

Let's say it's a 30 year fixed at 4%.

This means :

$763.86

Monthly Payment

$114,991

Total Interest Paid

$274,991

Total of 360 Payments

Apr, 2050


Let's say 1 year into it, I want to sell the house. Does this mean I have to sell the house for more than $274,991 to make money? Is this how all mortgages are? We're borrowing more than the value of the house? I'm so lost!

Please help clarify this for me. 

No because you don't have to pay the entire mortgage payment plus interest over the course of the loan, after 1 year the balance left on your loan would be $157,000 ish so to "make money" you just need to sell the house for $200k plus whatever you paid in interest to that point which in this case would be about $7k for that year. This is ignoring selling costs like a realtor, title insurance, closing costs etc.

If for example your mortgage allows you to pay early, and you won on jeopardy or whatever and have $20k to put towards your mortgage in a lump sum, you could do that, reduce your mortgage balance, pay less in interest each month, and pay off your loan sooner. Take a look at an amortization schedule, most loan calculators have them and it will tell you what you can expect to pay in principal and interest each month.

Hi Mike,
Let me try to break this down. In short, no, you would not have to sell it for $274,000 to make money. You could make a lot if you sold it for that. You just need to sell it for enough to cover the fees, and what you owe the bank at the time of the sale to come out in the positive. Let's take a look.

The purchase price is $200,000 the theoretical downpayment is $40,000 (You can find loans with smaller downpayments too, but we'll talk about that later.) This leaves the loan amount at $160,000.

For the purposes of this discussion, we're leaving out any fees or closing costs. They wont be enough to stop you in your tracks, but enough to know they're there, got it? :)

Now to look at your monthly payment, I like to use this website: www.amortization-calc.com 

Follow the link and punch in the numbers we just discussed. Keeping in mind, the loan amount is 160K.

This site gives you a table as an output with all kinds of info. Monthly payment is nice to see and the amount that goes to principle and interest is good too. This is similar to an Amortization Schedule that any bank or lender should provide you when getting a mortgage. The info I'd like for you to look at is the last column to the right: the "Balance."

This basically shows how much you still owe the bank each month. As each monthly payment is made, a portion of that will pay down the balance. Whenever you sell your home, you only owe the bank for this balance, and no more. It's likely that your house will be worth more than this when you sell it. We can go into the theories of appreciation later on. Just know that when you sell, you'll take the sale price, subtract necessary closing costs, fees, a cut for the realtors, and pay off this balance to the bank. What's leftover is what you keep.

The longer you stay (making your monthly payments) and the more your home's value appreciates, the more you stand to make when you sell it. There are all kinds of strategies people use to 'force' this number higher. The basic principle is pretty simple though: buy a house you can afford to make payments on for a long time. You'll build wealth in no time whether you decide to sell in one year or 100 years.

Clear as mud?

Originally posted by @Mike Rodriguez :

Makes total sense @Aaron K.  

@Paul Doty

The only thing that isn't clear to me is what's the purpose of the $274,991 number? Why is that shown and why is it irrelevant?

What they're saying is that over the 30 years it takes you to pay it off, you'll pay $274,991. Between the loan value and the interest, that's how much it will cost you. Kind of a shocker when you see it that way, huh?

 

Originally posted by @Mike Rodriguez :

@Paul Doty Yeah that's crazy! I wonder if other new investors see it this way as well.

Thank you so much for your time and detailed explanation!

No problem Mike. Glad I could help.

That difference between what you owe and what you sell it for is what we call equity. The concept of equity is pretty cool. It's a big piece of the equation for any investor.

Let me know if you have any more questions. Either on this thread or just send me a direct message.