I have Blogged about real estate since 2006 and I was fairly accurate in my prediction of the housing bubble and subsequent “POP” thereof. I tell you this to get your attention on what I am going to share with you now.
PEOPLE! You are STILL NOT paying attention! I thought that SOMEONE would have addressed this before now.
It is NOT the inflated value of the house that caused the problem, it is not the “toxic loans” that caused the problem, IT IS THE COMPOUND INTEREST that caused the problem.
I am a former Realtor in two states, I had licenses from 1974 to 1989.
I still hear people gauging their financial tolerance level by the sales price instead of the monthly payment. Then they work backwards to justify the payment and sometimes they go outside their financial tolerance level to make the payment. HELLO! Wake up and smell the coffee! Ignore the sales price because with compound interest you’ re going to be a slave for 30 years to this mortgage and you are going to pay 3 times the sales price anyway!
It is the payment, stupid… to use a political idiom.
Compound interest is compounding interest on interest of the unpaid balance. Your $250,000, 30 year mortgage at 5% interest will cost you $1700 (average PITI) a month with a total cost of over $600,000! At 10% interest the payment would be almost $3,000 per month, that would be around $900,000! The lender has made $650,000 in interest!
Why even care what the sales price is, it is the payment that you should build your budget around.
Compare that to SIMPLE INTEREST. $250,000 loan at 10% simple interest would be paid off in 183 payments at the same payment as in the above example. The lender has made $25,000 in interest!
Did you know that the scripture considers interest to be a sin? So is COMPOUND INTEREST A COMPOUND SIN?
Let me give you an example of compound interest. Let’s say that buying a house is a like a candy sucker. You know, one of those big all day suckers. When you first lick it is sweet and delicious (you just signed the contract with the bank). And then every lick it seems to get a little less sweet (about 2 years into the 30 year payment plan) until it becomes bitter (about 10 years into the 30 payment year plan and you realize you have only paid down about 15% of the loan) and then it becomes almost unbearably bitter (about 15 years into the 30 year payment plan, you are half way done and you still owe 70%).
Yeah, I know, most people sell within 7 years and so what is my point? THAT IS EVEN WORSE! You never get any equity unless the property appreciates. So, if the house does not appreciate you can’t afford to sell.
What is the solution? Change the system. Go back to simple interest like they did in the 1800’s and early 1900’s. Granted, it would eliminate much of the financial system that we have enjoyed up till now (enjoyed?), but is that really a bad thing? Is it working properly now? I guess it is, you are a slave and you are not complaining about your slavery.
Here is my favorite example.
“Put a frog in a pot of cool water on a stove and he will sit there. Turn on the flame and heat the water very slowly and he will sit there until he is thoroughly cooked.”
“But turn the heat up high and heat the water quickly, the frog will leap out.”
Hmmm. Kinda sounds familiar, don’t ya think. Are you a frog?
Do I have a 30 year Mortgage? No. I lease. I have a business, therefore I have income and the lease is a partial a tax write-off. This only works well if you have a business and you have income. I also have additional income generated from the building (mixed use), bottom line, it only cost me about $200 a month to live there. There are may creative ways to offset the Compound Interest as a savvy homeowner/business person.