Lesson Four: Pay Off Your Home in 7-10 Years
Okay, so you bought a house or are planning on buying a home soon. Good for you. Congratulations on taking this momentous step.
Have you stopped and considered just what you are getting into? We don’t mean to scare you with what we’re about to show you, but you really need to understand the system that you are participating in, which system has nothing even close to resembling your best interests at heart. Read on:
Let’s say that the home you are buying, or bought, came with a price tag of $170,000. This is about $25,000 less than the national average, but the national average is skewed because of still-elevated prices in the heavily populated coastal metropolitan areas.
So the home you have cost $170,000. Let’s now say that you were able to pay exactly 20% of the value of the home in down payment, or $34,000. You did this because you didn’t want to have mortgage insurance, which is a strategy that lenders use to make skim even more money from their borrowers.
Now we’re looking at a loan of $136,000, which is the remaining balance on the sale price of the home. But wait! There are all kinds of fees associated with taking out a mortgage, including origination fees, closing costs, appraisals and so on. So let’s round your mortgage up to $140,000.
Sound familiar? If your initial mortgage balance was $140,000, you are actually well outside of average. The average initial mortgage balance is actually right at $200,000.
Back to our $140,000. So the system in place, which we all just hop into because that’s what we’re offered and it’s what everyone does, is that we will pay back this loan over a certain period, usually 30 years, with interest.
Most of us figure that in 5 years, our loan balance will be down to about $120,000, since 5 years is 1/6th of the loan period and we really ought to be paying the balance down somewhat in that first 5 years, right?
Wrong.
Let’s add your interest rate to this equation. Recently, interest rates have been outstanding, so let’s say you have an annual rate of 6%.
Your mortgage payment for a term of 30 years, with 12 payments per year, will be $839.37. This doesn’t include homeowner’s insurance and property tax, both of which are usually paid into an escrow account (which just means a holding account) on a monthly basis. For a home of this value and with average insurance and tax rates, probably the entire monthly payment will be about $950.
But let’s stick with the $839.37. Do you realize that by the time you have paid off the $140,000 loan, you will have paid a total of $162.173.46 in interest alone?
That’s right. With an annual interest rate of 6%, you actually have a loan lifetime interest rate of over 110%.
Now some people figure that they will only own their home for about 5 years, or will refinance every 4-7 years (the national average), so they’re never going to pay that much interest.
Wrong again. Home mortgages are front-loaded for interest, because banks know the national averages and they want their interest as soon as possible. Because of this, inside the first five years you will bring your loan balance down to just over $130,000. You will have spent more than $50,000 on your mortgage inside those first five years, but you will have only paid it down $10,000! Where did the rest of that money go?
Daily accrued interest, my friends. Interest on your mortgage loan balance accrues every day, 24 hours a day, 7 days a week.
The bank just got $50,000 of your hard-earned money, and what did you get? Less than $10,000 in equity in your home. Shout for joy and throw a party; you’re another victim of a system that works because of ignorance.
Does this system make any sense? It does to the bank! And since this is the system we’ve all grown up with, we just slide into these loans without any idea of how we can get out of a system that has the bank making money on every side and us losing out every day.
A Better Way
Okay, now that you’re furious with the system and want to take the banks down, take a minute and catch your breath. If you’re not angry yet, re-read what we’ve described above enough times until you’re red in the face.
There are two fundamental ways to break this system and not have to pay so much interest. The first is simple: make extra payments every month on your loan. To do this, you will need to create a tight spending plan that allows you to make these extra payments. Then snowball your debt payment, as we described in lesson 1.
However, there is another way. There are a few companies in the U.S.A. that offer this system, and their approach is proprietary to them, but the principle that is used can be shared legally. This approach is something that has been used in New Zealand and several other countries for years.
In these other countries, the banks have provided a way to pay off home mortgages faster. They call it a mortgage checking account. It works very simply. When a borrower takes out a mortgage, the mortgage becomes an account with the bank. Then the borrower gets their regular paycheck. The borrower then deposits their paycheck into their mortgage account.
What does this do? This means that the entire amount of the paycheck is used to pay down the total mortgage principal. Remember when we mentioned daily accrued interest? With the principal on this mortgage paid down so significantly each month, the daily accrued interest is much reduced.
Now, the paycheck has to be used for more than paying down a mortgage, correct? These banks actually issue checks that are connected to the mortgage account. In this way, the borrower puts their entire paycheck into their mortgage account, but then they use checks connected to their mortgage account to pay other bills.
What this means is that the total amount of the paycheck lowers the principal of the mortgage for a short period. Then, as other expenses are paid out of the mortgage account, less of that paycheck is there, so that the mortgage principal inches back up.
But can you see the power of this system? If you deposit your paycheck at the very beginning of a month, your daily accrued interest is lowered because the principal has been knocked down. That interest increases slowly as you use your paycheck, but you are saving more on accrued interest than you would be making on interest in a regular savings account.
Now that’s pretty neat, isn’t it?
Problem is: banks in the U.S.A. aren’t interesting in helping borrowers pay off mortgages quicker. Instead, they end up using substance-less money as credit in other venues, which all builds up as thousands of banks do it, which results in a financial crisis—like the one we are having.
This system can be done here in the U.S.A., so don’t worry. The way the companies in this country do it is that they show you how to do the same system through using a line of credit. Usually this line of credit is a Home Equity Line of Credit (HELOC), and the companies have a system that helps you leverage interest rates between the HELOC and your mortgage to reduce your principal quickly.
Can you do this on your own? Sure, but it would be very difficult and you have to stay on the ball at all times. You can’t let any payments slip or be late in a money transfer, or you will end up getting hit hard with a high interest rate.
Thus, our recommendation is that you look into this system and take your time to find a company that is reputable and is not out to make a quick buck. Watch out for slick advertising and try to find a company that can show you real figures and clients. See if you can talk to real clients to get an inside look at how the system is working in the day-to-day of their lives.
Conclusion
Just like with every personal finance strategy, using a line of credit to help pay down the mortgage can be helpful, but dangerous if not done right. So, again, take your time and do your homework before deciding on a company that can help you.
And remember, strategies like this are only part of an entire lifestyle change that people in heavy debt need to make. Spending habits have to change, as do living habits. Costs must be cut and budgets need to be made and followed.
You’ve got the power to make a change. Remember that Einstein defined insanity as continuing the same actions over and over and expecting a different result. Don’t go insane. Get out of debt.