You must be mistaken…
It can’t be that much!?
Unfortunately, it is true. If you
borrow $100,000 for a home from the bank at 8.5% interest for 30 years you end
up paying $275,811.20. The problem with the typical mortgage is that interest is
compounded every month. At the end of each and every month, the person who holds
your mortgage will see how make principal you have remaining and then charge you
interest on that amount.
So, at the beginning of your loan, you are paying mostly
interest and paying off very little of the principal amount. Let’s look more
closely.
Assume you make your first payment on your $100,000 mortgage.
Payments would be $768.92 each month we said in How much am I really paying on
my mortgage or loan?
$100,000 - $768.92 = $99,231.08
Now we have to figure out what the
interest is each month. We already know that the interest for the year is 8.5%.
To calculate what it would be for the month, we simply divide it by 12.
8.5% divided by 12 = %0.70833 or
approximately .70 or .71 percent.
To find out how much we owe now, after
the first payment remember, we take the principal amount $99,231.08 and multiply
it by the monthly interest rate of .70833 percent. Let’s see how much interest
accrued at the end of the first month.
$99,231.08 times .0070833 (that is
%0.70833) = $702.88
That means that of the $768.92 payment,
$702.88 was interest!
This frightens me, and it should frighten
you too!
So, after the first payment of $768.92
on a $100,000 mortgage we still owe $99,231.08 + $702.88. We still owe
$99,933.96. The same thing happens month after month. In fact, it is not until
the 23rd year of paying on this mortgage that, when we make a
payment, less than half of our payment goes to paying off the interest for that
month.
This is why we end up paying over 2 and one half times the
amount we actually borrowed on a 30 year mortgage.
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