patrick.net

Are you asking the banks to charge you a lower interest rate in the first few years? That would be the only way how you could get what you're looking for.

I'm no finance major by any means, just an engineer... But the way I see it loan amortization is not something banks invented. Amortization is simply the description of the effect you're getting when borrowing a large amount of money over a very long period of time - at a fixed monthly payment rate.

Let me try to explain the phenomenon in two simple sentences:
"The more you owe, the more you pay in interest. If you want to pay the same amount each month, you will have to pay mostly interest in the first years."

Certainly amortization was not invented by the bank.

By definition you are paying your interest rate on the remaining balance of the loan each year. Simple math (Engineer myself here)

But again, I just have this unsettling feeling when I think how well the bank is positioned in all this and how short the short end of the stick is for the average property owner which holds on to their property only 5-7yrs.

You hold it longer, the gap closes... You enjoy the benefits of an equity surge, gap closes further.

Well, you're certainly making a good point here. Essentially you're pointing out how crazy it is that people take out 30yr loans for something they plan to hold on to for only 5-7 years.

If you took out a 5 year loan, then your equity situation would certainly look much better, wouldn't it?

But since home prices are as insane as they are, people are being pushed to extremes. And there's even talk of 40 year loans. Which is especially ludicrous given that the monthly payment would be reduced only minimally...

So, yes - I see a 30 year loan is money thrown away. When I buy I will definitely not do more than 20 years, hopefully 15...

Banks are well positioned? Well yes, they certainly benefit from inflated home prices - as long as the borrower can pay back the loan in the end :-)

Dave, exactly right... The same loan over a 15yr period instead of 30yrs would have you paying more principle than interest in the first year...

Most people who are in a position to buy will stretch themselves for the larger home with a 30yr than a smaller home with a 15yr, as I am sure you know.

And that was really the point I was trying to make... How insane it is for the average homeowner to purchase a home on a 30yr loan that they won't live in past 5-7 yrs.

And the bank "banks" on that fact.

DaveM_Renter says

Banks are well positioned? Well yes, they certainly benefit from inflated home prices - as long as the borrower can pay back the loan in the end :-)

I am am grabbing my protest sign and heading to downtown Oakland ;-)

Show me the ROI tables for 1%, 2%, and 3% annual appreciation. Then we can talk. (And yes, you can also have extreme losses due to leverage).

BayArea says

Anyone know the history on loan amortization and when it became a generally accepted practice in real estate?

As people said above, this is just math. You pay more interest on 0.95X than you do on 0.2X (where X is the original principal), so more of your payment at 0.95X is interest. Most every loan works like this, car, student, etc. Credit cards are weird because you don't have fixed level payments. Student loans can also have non-fixed payments, although you will still see principal paid down with mostly normal amortization.

BayArea says

By definition you are paying your interest rate on the remaining balance of the loan each year. Simple math (Engineer myself here)

But again, I just have this unsettling feeling when I think how well the bank is positioned in all this and how short the short end of the stick is for the average property owner which holds on to their property only 5-7yrs.

The first paragraph I quoted makes a lot of sense. I am not so sure about the second paragraph. Interest is charged on the amount of the loan outstanding. If the homeowner chooses to prepay, that is their choice, but the bank should still charge them for the principal outstanding each year.

If your point is that this does not seem like a good deal for the homeowner - then I agree. The homeowner should take a smaller loan with a shorter time frame if they don't want to pay as much interest. Homeowners should not buy "starter homes" unless they anticipate capital appreciation.

PRIME says

If your point is that this does not seem like a good deal for the homeowner - then I agree. The homeowner should take a smaller loan with a shorter time frame if they don't want to pay as much interest. Homeowners should not buy "starter homes" unless they anticipate capital appreciation.

Well, there's a secondary point there, which is that people should not buy starter homes (unless they anticipate high capital appreciation) because of transaction costs in addition to this issue. You have to pay the realtorused house salesman and maybe you paid some costs for your loan. These can add up and kill any savings you may have had over renting in the short-term.

Also, when people overpay for starter homes, it sometimes makes it harder for them to buy their "real home." This was often the case during the most recent boom in many parts of California. Many places, you could rent for cheaper, but people (non-flippers) wanted to buy just to say they bought (even though they had no equity, which is basically renting; interest only is certainly just renting). That means, not only did they get slaughtered when the market tanked, making it difficult or impossible to move up, but they also progressively saved less money per month than they would have saved while renting, so they are even further behind in their plan to move up. People use the cliche that renting is "throwing money away," but in many of these cases, buying was throwing money away.

I read somewhere that amortization was designed so that the monthly payment on a loan never changed over the life of the loan. I suppose an alternative would be to take the loan amount, figure the interest to be paid on the life of the loan, and then divide that into equal payments.

So let's take 100k, 30 years @ 5%. Total interest is 93255.78. Monthly payment is 536.82 (100,000+93255.78 divided by 360), half goes to principal half goes to interest. After ten years you pay back 32209 in interest and 32209 in principal. You still owe 67790.70 on the loan. The bank still does well, pulling in 32k in interest.

With the way loans are amortized, however, you would still owe 81,144.17 in principal and you would have paid 46099.58 in interest over those ten years.

Keep in mind the monthly payment is exactly the same either way. I just figured this all out so my initial statement about keeping the monthly payment the same is clearly NOT the reason for amortization. I assume I am not understanding something since I know nothing of banking or finance. But it seems to me that the existing structure is there to benefit one party more than the other.

atst1138 says

The bank still does well, pulling in 32k in interest.

No it won't, they just receive 3.2% interest instead of 5% (3,200 interest on 100K principle). In the 20th years when loan balance is 33,000 and interest is stil a flatl 3,200, am I obligated to pay 10% interest rate?

Your method will work, only if banks double your borrowing cost and/or have obscene pre-pay penalty. The current amort method assures the lowest interest rates.

SFace says

No it won't, they just receive 3.2% interest instead of 5% (3,200 interest on 100K principle). In the 20th years when loan balance is 33,000 and interest is stil a flatl 3,200, am I obligated to pay 10% interest rate?

Your method will work, only if banks double your borrowing cost and/or have obscene pre-pay penalty. The current amort method assures the lowest interest rates.

Like I said I'm not in finance but how does making 32k in interest on a 100k investment in 10 years amount to 3.2%? I agree though that the pre pay penalty would have to be high, clearly no one expects the mortgage to fully amortize which makes the front loading of interest even more awful for the borrower.

BayArea says

At the end of the 7yr period for example, you gave the bank $41,808 in interest, you paid $20,177 in principle towards the house, and you still owe them 87% of the original amount of the loan. Can the bank be positioned any better?

And yet we all sign up for this willingly, lol ?!

Well, when you rent... you pay 100% essentially in interest.

Say you rent a 2 bedroom apartment for $1700 a month in LA area (average rent i believe)... Or have a $360K loan at 4% interest...

You are paying the same in principal and interest as renting... Except instead of the full $1700 going to a landlord... With the home loan you are at least pumping $528 a month into your home equity.

The loan amortization isn't the problem.. it's basic math. Car loans work the same as home loans... Atleast with a home loan you get to deduct the interest payments and historically home prices rise overtime unlike cars.

But its not basic math. My numbers show that the same loan, interest rate, total interest paid, length of the loan can be paid monthly at the same cost with two very different interest:principal ratios. The bank's way front loads all the interest. At the end of the loan you pay back all the principal and the exact same amount of interest. All that differs is the way the interest is paid. I'm really surprised people are so ho hum about all of this.

I understand the current system will never change and it keeps rates down overall but if you were moving every 5-10 years the equal interest:principal calculation is the far better deal for you, and this is why it doesn't exist as an option. Rents and all that is irrelevant to me who doesn't think in cash flow or ROI but what the total bottom line is. How much will this house cost me? Shoot they could even have some type of pre-pay fee at closing. I suppose in the end the current amortization approach makes things simpler for the buyer, but at what price?

BayArea says

I am illustrating the amortization of a $150K loan (4.25%) over 30yrs. Note that after your typical 5-7yrs of homeownership, you have paid:
Interest: $30,486 - $41,808
Principle: $13,788 - 20,177
Amount owed to Bank: $129,823 - $136,212

You (or we) as homeowners owe Interest on the outstanding balance each month. Yes, up front interest piece is higher portion of payment vs tail end of your loan. Its not rocket science.

atst1138 says

But its not basic math. My numbers show that the same loan, interest rate, total interest paid, length of the loan can be paid monthly at the same cost with two very different interest:principal ratios. The bank's way front loads all the interest. At the end of the loan you pay back all the principal and the exact same amount of interest. All that differs is the way the interest is paid. I'm really surprised people are so ho hum about all of this.

No, you're getting this all wrong and don't really know what you're talking about. Sorry to be blunt. You just aren't doing the math right. The principal is higher at the beginning, so you must pay interest on more principal at the beginning. Thus, you pay down less principal at the beginning.

Let's say you get $125K house with 25K down, for a loan of $100K.

The equivalent interest in your first month at 4% would be 4% of $100K divided by 12 = $4000/12 = $333.33.

Halfway through the loan, the principal remaining is $64,542.80 before you make your 181st payment. So 4% of that divided by 12 = $2581.71/12 = $215.14.

If you have level payments, you will necessarily pay $333.33 - $215.14 = $118.19 in principal extra for that 181st payment than for that 1st payment.

The problem is that you're being ho hum about the way interest is being paid. You cannot allocate the interest willy nilly as you are suggesting because otherwise you will be accruing interest (negative amortization) early in the loan and paying more interest later in the loan. Why should the bank take the risk of negative amortization (most recent real estate boom excepted)?

If you want more principal paid in the early months, you would need to make larger payments early in the loan and smaller payments later in the loan. For example, let's say you wanted to pay principal evenly through the 30 year term. $100,000 over 360 months is $277.78. So in month 1, you would pay $277.78 (of principal) + $333.33 (4% of $100,000 divided by 12) = $611.11. Then in month 181, you would pay $277.78 (of principal) + $166.67 (4% of $50,000 divided by 12) = $444.45. If you give up level payments, you can have more principal early on.

atst1138 says

So let's take 100k, 30 years @ 5%. Total interest is 93255.78. Monthly payment is 536.82 (100,000+93255.78 divided by 360), half goes to principal half goes to interest.

This makes no sense. If you pay $536.82/2 = $268.41 in interest, you are only paying 3.221% interest that month. Why? Because $268.41*12 = $3220.92.

It seems like the real reason a payment remains the same in an amortized loan is to disguise or obscure the amount of interest the borrower is paying to the lender. This is probably why Regulation Z (otherwise known as the "Truth In Lending Act" or TILA) came about - which shows you the overall interest you pay to the lender over the life of the loan. Perhaps the perception -prior to the passage of this bill (1968) - was that lenders amortized loans were not so "truthful" to the uninformed public?

There are other payment stratagies to use, however. For example, it is said that if you make one extra payment per year, you can shave 5 1/2 years off the amortized schedule on the loan - so a 30 year loan effectively becomes a 24 1/2 year loan, etc...

See here:
http://www.bankrate.com/brm/news/DrDon/20030506a1.asp

Yeah it couldn't be equal interest and principal each month if the total paid is different (100k vs 93k).

Rather then try to resurrect this idea, is there ANY other way to conceive of a mortgage product that was more conducive to American home ownership behaviors? I suppose the 10 year ARM will be the answer.

Everone wants a free lunch but not the obligation to pay !

No wonder our credit has balloned.

Oh well..

lotr1978 says

Rather then try to resurrect this idea, is there ANY other way to conceive of a mortgage product that was more conducive to American home ownership behaviors? I suppose the 10 year ARM will be the answer.

How about bi-monthly payments on a 15 year loan (if it's affordable)?

lotr1978 says

Rather then try to resurrect this idea, is there ANY other way to conceive of a mortgage product that was more conducive to American home ownership behaviors? I suppose the 10 year ARM will be the answer.

Thats why the Mortgage Int% Deduction was created.

lotr1978 says

Rather then try to resurrect this idea, is there ANY other way to conceive of a mortgage product that was more conducive to American home ownership behaviors? I suppose the 10 year ARM will be the answer.

Depends. If you know you will stay 5 years, the 5/1 ARM might make sense. Similarly, if you know 7 years, 7/1, and 10 years, 10/1.

PenFed has an interesting ARM -- a 5/5. Oh, and it looks like they just added a 3/5 ARM, I hadn't seen that before:

https://www.penfed.org/productsAndRates/mortgages/mortgagecenter.asp

There is a 2% cap on the 5 year reset, and an overall 5% cap on total interest rate resets. The 3/5 starts at 3%, so in 3 years, your max rate would be 5%, and in 8 years, your max would be 7%, and in 13 years, the max rate would be 8%. The 5/5 works similarly, but is at 3.375%, so in 5 years, your max would be 5.375%, in 10 years, 7.375%, and in 13 years, 8.375%. Could be a risk worth taking, if you're pretty sure you won't stay longer than 8 years for the 3/5 and 10 years for the 5/5. Either 5% or 5.375% would still be very low by historical standards, and it's not guaranteed to get there. You can also re-evaluate upon the first reset, of course, if you don't have a set timeline.

AND...they do it all with 'conjured' money! Now THAT'S a racket!

SNL19067 says

AND...they do it all with 'conjured' money! Now THAT'S a racket!

True SNL the paper is the swindel. All of the natural resources they take have value. Things you want and need. They use the paper to swindel those resources from other countries and this one. See its the time value OF LABOR for that resource. Above example a house that took 3 MONTHS TO BUILD with swindeled material. TAKES YOU 30 YEARS OF LABOR TO ACTUALLY OWN IT. See if they own everything down and up the fucking block. Then its your LABOR they want giving you little as possible for it (see mark ups). The more they give you by the way the more they own you. No one owns their house that they don't own. IE if they can throw you out. Take your car. It ain't really your house or car.

BayArea says

Hi folks,
The topic is on mortgage loan amortization.

Hey Bay area.

Also try this caluculator it gives in plain how much interest you pay. Thats bankrate it appears and that is the fucking wolf believe me.

http://www.amortization-calc.com/

Many here do not understand amortization.

Lets say I borrow $100 from you at 12% annual interest (1% per month). A loan like that amortized over on year has a monthly payment of $8.88/mo.

The first month I owe you the 1% interest on the $100.00 or $1.00 so $7.88 of my payment goes to principal.

The second month I owe you $100.00 minus the $7.88 I paid you last month so my balance is $92.12. This month I owe you 1% of $92.12 or 92 cents of interest. I pay you my standard $8.88 so $7.96 goes to reducing principal.

The third month I owe you $92.12 minus the $7.96 principal I paid you on the second month so my balance is $84.16. My 1% interest due on that balance is 84 cents...

I don't know if you can get the gist of this but the reason interest seems front loaded is that you have to pay the interest on the money you owe and you owe more at the beginning.

You could devise a loan where you pay half to interest and half to principal (or any combination like that) but the payment would not be fixed. If you borrowed $100,000 at 4% with that program you would owe $333.33 in interest the first month and $333.33 in principal for a total payment of $666.67 the first month. The second month your payment would be $664.44 and it would continue to fall each month. The fixed payment on that same $100,000 loan would be $477.42.

BTW: APOCALYPSEFUCK is Tony Manero, your payment on the $5 million loan amortized over 100 years is about $17,000 per month.

Here it is Bay one bitch'n calculator. Took me a while to find. Bank rate is confusing to say the least try this one. This sums it up and spells it out for the most part. Try looking at that debt service constant. Curious thing isn't it?

http://www.bretwhissel.net/amortization/amortize.html

It doesn't round to the nearest cent so be careful. They would not want to cheat you out of one cent.

It's mortgage "principal."

Principal. Principal, principal, principal.

I don't need to hear any more about mortgage "principle."

Amortization is just a way to mathematically figure out how to make a series of payments equal over the life of a loan. The formulas are also helpful for other investments. ie: lets say you run a small restaurant, you are offered a new espresso machine that you believe will make you $200 per month in extra profit. The machine will last 5 years and costs $10,000. The return on that $10,000 investment is 7.42%. If you think you should be making a 15% return on investment you would either have to pay $8407 for the machine or figure out a way to make $237.90 per month off of it.

Very handy formulas for many things besides loans.

Here are the formulas to solve for each variable:

P = A * ( R - 1 ) / ( 1 - R-N )

Similarly, other amortization formulas are as following:

Amount (A):
A = P * ( 1 - R-N ) / ( R - 1 )

Term(N):
N = -ln [ 1 - A ( R - 1 ) / P ] / ln[ R ]

Payoff (or balloon) (P[n]):
P[n] = (A - P * ( 1 - R-n ) / ( R - 1 ) ) Rn

Amount owed after n payment (A[n]):
A[n] = ( A - P * ( 1 - R-(n-1) ) / ( R - 1 ) ) R(n-1) - P

A = payment Amount per period
P = initial Principal (loan amount)
r = interest rate per period
n = total number of payments or periods

Of course, if the numbers were reversed as in a 10 year loan, the payments would be $1,500+, the majority of which goes to principal. The reason people sign up for 30 year loans is to keep their monthly payments managable; and, if you want to pay more in principle (as your financial circumstances improve) you can always make extra payments which become direct principle reductions.

yes....a 30 year note is likely going to appear to benefit the bank more than you. however, you need the loan and the bank has the $. it's really that simple. amortization makes perfect sense to me. it's math. just my own opinion, but if i were planning on only staying in a home for 5 year, then i would rent. i bought (or borrowed rather) a home because i plan on staying long term. i could pay $1000/month for 30 years and own a house at the end.....or i could rent the same home for $1000/month for thirty years, and then continue to rent it for the rest of my life.

i view it as somewhat part of my retirement plan. i realize that things could change....but the goal to me is to have no payment, neither rent nor mortgage, when i retire.

auto loans are much more in line with the average amount of time you will have that vehicle, and because of this you pay significantly less interest, as a % of the principle, than you do on a home with a 30 year note. so do a 5-7 year loan on a home and you will pay MUCH less to the bank in interest.

and i don't believe that anyone has pointed out that you also receive the greatest tax benefits in those first 5-7 years. now i'm not big on the tax breaks of homeownership (for the median home, it is very little more than the standard deduction), but if you do itemize, then you are writing off more interest in those first 5-7 years as well. just thought i'd throw the tax thing in to the discussion. (nevermind the fact that you can sell a residence for a large gain, tax free)

Thanks Jonny G for confirming the relationship between stable payment and amortization. My math was wrong, hastily done. I get the concept of amortization but am interested in exploring other options which don't seem to exist. Many posters suggest there is no other option because of the math - I get it, you owe more at first so interest is higher up front. But your example here

>>>>>>>>
You could devise a loan where you pay half to interest and half to principal (or any combination like that) but the payment would not be fixed. If you borrowed $100,000 at 4% with that program you would owe $333.33 in interest the first month and $333.33 in principal for a total payment of $666.67 the first month. The second month your payment would be $664.44 and it would continue to fall each month. The fixed payment on that same $100,000 loan would be $477.42.
>>>>>>>>

I assume this earns the bank less interest overall? If given the choice why is a DECLINING payment ever a bad thing? In this scenario if you can afford payment 1 then surely you can afford the remaining 359 payments that are trending lower. Essentially it would require a broker to layout two options for a fixed rate mortgage.

If you pay your mortgage according to the terms that the bank gives you, you're as much a sucker as if you paid your credit card statement according to the terms the bank gives you.

HydroCabron says

It's mortgage "principal."

Principal. Principal, principal, principal.

I don't need to hear any more about mortgage "principle."

Does your computer talk to you?

atst1138 says

I assume this earns the bank less interest overall? If given the choice why is a DECLINING payment ever a bad thing? In this scenario if you can afford payment 1 then surely you can afford the remaining 359 payments that are trending lower. Essentially it would require a broker to layout two options for a fixed rate mortgage

I gave another scenario like this above:

corntrollio says

If you want more principal paid in the early months, you would need to make larger payments early in the loan and smaller payments later in the loan. For example, let's say you wanted to pay principal evenly through the 30 year term. $100,000 over 360 months is $277.78. So in month 1, you would pay $277.78 (of principal) + $333.33 (4% of $100,000 divided by 12) = $611.11. Then in month 181, you would pay $277.78 (of principal) + $166.67 (4% of $50,000 divided by 12) = $444.45. If you give up level payments, you can have more principal early on.

You could do this yourself. Just pay more than your fixed payment in the early months and have the bank apply it to principal. Why would a broker need to lay out this option?

Of course it earns the bankster less interest -- you are paying off principal faster. Any time you pay off principal faster, you pay less interest.

Eggman says

If you pay your mortgage according to the terms that the bank gives you, you're as much a sucker as if you paid your credit card statement according to the terms the bank gives you.

Exactly.

10 year mortgage is extremely smart. Payments are high.

See if you let the builder handle the loan. It's very simple. If you knew how much a builder makes on a single home. You would understand quite well. Why it is well worth it to them. Builders make a KILLER MARK UP on every house they build.

Resale is no problem. I do it all the time. Or did, only a crazy person buys in a negative equity market.

See if the builder does the loan and the buyer defaults. He keeps the down payment and all payments. He puts another buyer in and has NO LENDER TO WORRY ABOUT.

Frankly if you knew how much a builder makes on a house in addtion to the vig you have to pay on your current loan. If you are in a new house. You could just get a little crazy. You saw my example on the previous page of 139 percent interest paid back IN ADDTION to the 100k principle. Just add about oh another 50 to 60 percent to that. Look its gouging, you sure as fuck can't get away with that. With like selling your used car to someone. No ones that fucking stupid. Deal is the book is there bluebook or whatever will rat you out. As for a new car used they could care less your hair would stand on end for the current markup. They have increased it to the ridiculous over the years. You don't know what it costs and how much is made on a new build. A liter of coke - 142 percent made costs about 3c a bottle to make unless on sale. So on there is huge markup in everything you buy. THESE PEOPLE ARE GOUGERS. Please understand that.

Those occupy people have a lot on the ball in my opinon. I hope they burn the fucking place down. Frankly whats been going on with things. Is no way to do commerce. If you ask me these occupy guys aren't political. They are just damn sick and tired of these slick talking swindlers running and thieving from many of the governments of the world and people.

So look up there the builder makes the loan at no interest and makes off really well. As for resale I can get into that with you later. Again in this current enviornment. With financing the way it is. DON'T BUY FOR ANY REASON. Unless you can get something at say 40% under last falls market. It's getting there folks.

duh...

that is why ARM is much better. Pay much less on interest.

if you can guarantee your job(to be able to refi) and you don't mind refinancing every few years or whenever you feel rates are in your favor, then ARM is for you.

if you like peace of mind, lock on a fixed interest, then you do the 30 year fixed.

ArtimusMaxtor says

If you ask me these occupy guys aren't political. They are just damn sick and tired of these slick talking swindlers running and thieving from many of the governments of the world and people.

You're damn right. I make an awesome income but have gone OWS. I support them 100% and have and will continue to help them out anyway I can. I am totally sick of the outrageous theft taking place in direct sunlight by wall street and both political parties. They are tear gassing and beating the shit out of OWS, even decorated veterans, but the REAL criminals are laughing out loud as they continue to steal and not ONE arrest of a government official or wall street person caught stealing. This is why I am pissed off and angry as hell. I am completely dumbfounded as to why very few are. Guess they have been TOTALLY brainwashed with little chance of us deprogrammers EVER getting through to them.

The bank isn't really worried if it makes more or less interest over the long term. In fact, if interest rates increase they would prefer that you just pay off the loan. They want the current rate now. You can refinance next month and pay off the loan or keep it for 30 years. It doesn't matter. In fact, the "bank" usually sells the loan so they don't make the interest anyway.

Everyone seems to be looking for some sort of conspiracy but there isn't one here.

Oh, and Artimus, builders have much smaller margins than you imagine. DR Horton (one of the largest builders) had gross margins of 16% last quarter. Their net profit was just over $35 million on $1.1 billion in sales or about 3%. That is $6,000 on a $200,000 house.