30-Year Mortgage Demystified:
An Opinion on America's Single Largest Debt and Asset
For a lot of Americans in 2008, a paradigm shift occurred with institutional finances. As the mortgage meltdown and the real estate crisis continued from 2007 and has bled into 2008, a lot of Americans, who had previously been working long weeks and long hours merely to be good borrowers in the eyes of the big banks, have simply let go. They not only let go of their mortgage payments, which at times doubled and tripled almost instantaneously, but these Americans let go of the notion that their homes were assets.
Through these times of change, we have witnessed big banking at its best. We have witnessed how much your bank really does care for you. Only until George W. Bush passed legislation to do so, did banks begin to reach out to delinquent homeowners. Shocking right? Another realization, which will be important long after this crisis is over, is the fact that the 30-year mortgage is an outdated and obsolete financial tool. In fact, the 30-year mortgage is the most common, the most revered, and the most advertised for one simple reason: it is the most profitable loan for the big banks.
Simply put, the 30-year mortgage is a guaranteed and secure mortgage not only for the homeowner. It is a guaranteed and secure investment for the banks. What would you think if you could go out and obtain an investment that would yield you 6% for the next 30 years? What if you knew how to invest that 6% return and, while using compounded interest as banks do, make it grow to 12% or 15% or 20% in returns? Would you also lend an initial amount to get that 6% return, only to invest that 6% and make it equal to 12%, 15%, or 20%? Well, big banks have realized this concept and have been utilizing compounded interest, hedging, and investing since the inception of big banking in the United States.
A 30-year mortgage is by design a stable, secure, and guaranteed investment for the bank-not you. Here is why...
Our prime example will be based on a $300,000 loan amount you will borrow for a home mortgage at a fair and fixed interest rate of 6%, paying down both principle and interest over 30 years.
- By design, the 30-year fixed mortgage yields a lot of profit to the bank. Borrowing this $300,000 over a course of 30 years will yield the bank $347,515.59 in interest AKA profit. Read that again. For you to borrow $300,000 over a course of 30 years, you will pay back $647,515.59 in total over the 360 payments. So subtract the initial $300,000 from the total paid, and the interest paid to the bank is $347,515.59. A pretty good investment, right? (For who though?)
- By design, a 30-year fixed mortgage is an inverted tool devised to benefit the bank by hedging on the fact that you will refinance in years to come. So banks make more money off of you in the initial years of the mortgage and when you do refinance, they will be paid their initial lent amount. Borrowing this $300,000 will cost a monthly payment of $1,798.65 per month, every month, for 360 months. From the first payment of $1,798.65, the bank will claim $1,500 in interest and the remaining $298.65 will chip away at the hefty $300,000 loan (also known as principle balance). The second payment will pay $1,498.51 in interest to the bank, while chipping away $300.14 in principle balance. Not a whole lot of chipping away compared to interest paid, right? Well, after the first year, you will have paid $17,899.80 in interest to the bank, while only chipping away $3,684 in principle of the original $300,000 loan amount. Why isn't the loan designed to pay half interest and half principle? Wouldn't that make more sense?
- By design, the 30-year fixed mortgage is truly an interest only for the first 10 years anyway, but just at a higher interest rate. On any given day, a 30-year fixed mortgage compared to a 5-year interest only or a 7-year interest only is a much higher interest rate. For example, the rate on a 30-year fixed will be 6% while the rate on a 5-year interest only or 7-year interest only will be 5.5%. The way a bank will justify this is by stating that a 30-year fixed provides more security and also pays down the principle of the mortgage. So while you can get a 5.5% for 5 or 7 years with a lower payment and amount of interest paid (lower rate), you will prefer a higher rate of 6% simply because it is instilled into your belief system that you will remain in this loan for 30 years and it is in your best interest to do so.
- By design, most Americans do not ever stay in the same mortgage for 30 years. On average, Americans refinance every 18-24 months. Our banking system likes to keep economic activity going. So every two years or so, rates will be adjusted. This adjustment will stir up economic activity and will encourage you to refinance and borrow more money, and spend more money. Isn't that what equity appreciation encourages? Most Americans will never pay off their mortgage and will simply preserve the equity during downtimes (such as now), and will capture and utilize equity, almost as income, in uptimes like the 2002 to 2006 real estate "boom."
- By design, Americans could and should invest more into their own banks ("Bank of You"). There is no shock that Americans have a poor level of saving and investing compared to debt and obligation. Instead of assets, Americans acquire debts. Instead of saving accounts and checking accounts and stocks and bonds and notes and CDs, Americans like credit cards, toys (e.g. boats, motorcycles, cars), nice jewelry, luxurious furniture and televisions, etc. A 30-year fixed mortgage encourages this. It gives you a fixed and stable payment for 30 years, and encourages you to be a good working-class citizen simply to pay off a higher payment at the end of the month. How about if you had a lower interest only payment (since that's what a 30-year fixed really is for the first 15 years anyway) and invested more heavily into your own saving account, checking account, stocks, bonds, foreign commodities, gold, silver, notes, CDs, etc. Why not use the concept of compounded interest and precise investing, just like banks do, and invest every month into the Bank of You to accumulate appreciating assets rather than depreciating assets or debt?
- By design, Americans do not understand the function and utility of money. Money is not necessarily that green paper in your wallet or purse. Money is the concept of power and ability and trade. You give me a green paper with $20 stamped on it, and I give you a box of lemons. However, money by design depreciates in value. If you analyze money over the past 40 years, it has consistently gone down in value. In theory, you only needed a green paper with $5 stamped on it in 1980 for that box of lemons, but needed a green paper with $10 stamped on it in 1990 for that same box of lemons. You now need a green paper with $20 stamped on it for that same box of lemons. So in theory, money needs to constantly be appreciating in order to fight off natural depreciation and inflation. So as the banks use compounded interest, hedging, and investing, Americans should do the same to ward of this natural phenomena.
- By design, real estate in America will always appreciate and most Americans will capture profits based on this mechanism in uptimes. If you compare a home in San Diego, California in the year 1985 and in 2005, you may notice that the cost of the materials used to build the home, for the most part, has not gone up dramatically. You may notice that the cost of the actual sod on the lawn, for the most part, has not gone up dramatically. You may notice that the cost of the tile on the porch, for the most part, has not gone up dramatically. You may notice that the cost of the wood, for the most part, has not gone up dramatically. You may notice that the cost of the fence, for the most part, has not gone up dramatically. You may notice that the cost of the sink and kitchen fixtures, for the most part, has not gone up dramatically. The bottom line is that, for the most part, the cost of building that home has not gone up much dramatically. [Obviously, we have to consider inflation so the costs have gone up naturally but increases in income retaliates this.] These costs simply are not the driving forces in real estate value appreciation; the bottom line is that the physical makeup of the home itself does not cost much more today than it did years ago. The most relevant fact is that the value of the actual real estate-the property-has appreciated and gone up. Real estate-the property-by design can not be grown; it can not be harvested; it simply is not an infinite commodity. It is something scarce and finite-it will one day run out. That is why we are now building up (with major high-rises) and not building out; the land we have our homes on is scarce and that is the driving force in real estate appreciation and increases in value over the long-term scale.
- By design, Americans will always be in debt-unless they change their mode of thinking. Sadly, you may have worked all your life to pay off a 30-year fixed mortgage. After 30 years, you may see that you have not saved much in your own saving account, checking account, stocks, bonds, foreign commodities, gold, silver, notes, CDs, etc. You will at that time decide that a reverse mortgage makes most economic and financial sense. So after 30 years of long and hard work dedicated to paying off that home will result in you giving that home back to the bank and requesting a monthly allowance AKA a reverse mortgage. At that time, the bank will still use the power of investing and compounded interest of your reverse mortgage to make more money and become wealthier. Pretty interesting, right?
As I hope, you should see by now that the mortgage should by design be a financial vehicle used to drive and further wealth accumulation and your net worth. It should actually be an asset, and not simply a debt, a burden. If you are working for your home and your mortgage, you should consider having your home and mortgage work for you, just like your money should be working for you. Careful, strategic, and proper mortgage planning is the fundamental escape from the traditional mode of thinking that glorifies and adores the 30-year fixed debt. Begin investing in the Bank of You today.
Freedom Lending Group, Inc.
Copyright 2008 Cyrus Khadivi. All rights reserved.
Subscribe to CommentsComment