Homeownership has been sold to Americans as the American Dream. This dream is also sold to citizens of other developed countries such as Canada, Australia, New Zealand, France, and the United Kingdom.
Governments and financial institutions promote this dream to the general population.
The dream is to own a home. To build equity in a home.
You need a mortgage to buy a home? Your local bank will extend credit to you.
You need an incentive to buy a home? Your local government will offer tax credits to you.
However, what is not offered or sold to the general population is financial knowledge about real estate. Very few people truly understand how real estate numbers work.
How much of your hard-earned cash is actually going to Mortgage Interest versus Equity/Ownership? How much of your paycheque is going to enrich the bank? How much of your paycheque is actually going to build your ownership position in the home?
Let’s deep dive into your real mortgage amortization schedule, your payment plan.
What Is a Loan Amortization Schedule?
An amortization schedule is a table of periodic loan payments that details the portion of your payment that is allocated to Principal and the portion of your payment that is allocated to Interest until the loan is paid off at the end of its term.
Each payment may be the same amount but the portion allocated to Principal and Interest changes over time.
Of course, the ideal scenario for any borrowing homeowner is to pay off the Principal as early as possible in order to eliminate debt and build as much equity in the home as quickly as possible.
However, early in the amortization schedule, because a larger portion of the outstanding loan balance amount is due to the lender, most of each payment is allocated to the Interest owed to the lender. Not to the Principal.
The interest calculation is based on the size of the outstanding loan balance.
Later, as the outstanding loan balance is reduced, the interest payment is also reduced. And most of each payment is allocated to paying off the principal, which builds Equity in the home.
Initially, Mortgage Payments Are Mostly Interest
Let’s explore this subject with an example. Let’s assume you purchase the average home in America for $250,000 along with these common terms:
You take out a standard fully-amortizing fixed-rate mortgage at 4% for a 30-year term. Assume you make the expected 20% down payment as well.
We should be including your additional costs such as real estate agent fees, home insurance, repair and maintenance costs, and property taxes that you will pay over time. But to keep this example simple, we’ll exclude those costs here.
So your bank will enter these numbers in an amortization calculator:
Home Price: $250,000
Down Payment: $50,000
Loan: $200,000
Interest Rate: 4%
Loan Term: 30 years (360 months)
Monthly Payment: $954.83
Each month, you have to pay $954.83 to your lender. After 360 months, the loan and interest will be paid off.
Then, you will technically own your home free and clear. You really don’t own the home outright because you still have to pay property taxes on the value of the home. If you are delinquent in your property tax payments, you can still lose your home.
But that’s a discussion for another time. Let’s focus on your equity today.
How Much Equity Are You Building in your Home?
Let’s look at the 30-year amortization table below produced by the amortization calculator:
| Beginning Balance | Interest | Principal | Ending Balance | |
| 1 | $200,000.00 | $7,935.92 | $3,522.04 | $196,477.93 |
| 2 | $196,477.93 | $7,792.41 | $3,665.55 | $192,812.36 |
| 3 | $192,812.36 | $7,643.07 | $3,814.89 | $188,997.45 |
| 4 | $188,997.45 | $7,487.64 | $3,970.32 | $185,027.12 |
| 5 | $185,027.12 | $7,325.89 | $4,132.07 | $180,895.03 |
| 6 | $180,895.03 | $7,157.53 | $4,300.43 | $176,594.59 |
| 7 | $176,594.59 | $6,982.32 | $4,475.64 | $172,118.94 |
| 8 | $172,118.94 | $6,799.97 | $4,657.99 | $167,460.95 |
| 9 | $167,460.95 | $6,610.19 | $4,847.77 | $162,613.19 |
| 10 | $162,613.19 | $6,412.70 | $5,045.26 | $157,567.92 |
| 11 | $157,567.92 | $6,207.16 | $5,250.80 | $152,317.10 |
| 12 | $152,317.10 | $5,993.21 | $5,464.75 | $146,852.35 |
| 13 | $146,852.35 | $5,770.57 | $5,687.39 | $141,164.96 |
| 14 | $141,164.96 | $5,538.86 | $5,919.10 | $135,245.86 |
| 15 | $135,245.86 | $5,297.70 | $6,160.26 | $129,085.60 |
| 16 | $129,085.60 | $5,046.74 | $6,411.22 | $122,674.36 |
| 17 | $122,674.36 | $4,785.53 | $6,672.43 | $116,001.93 |
| 18 | $116,001.93 | $4,513.67 | $6,944.29 | $109,057.64 |
| 19 | $109,057.64 | $4,230.76 | $7,227.20 | $101,830.44 |
| 20 | $101,830.44 | $3,936.30 | $7,521.66 | $94,308.78 |
| 21 | $94,308.78 | $3,629.88 | $7,828.08 | $86,480.69 |
| 22 | $86,480.69 | $3,310.96 | $8,147.00 | $78,333.66 |
| 23 | $78,333.66 | $2,979.02 | $8,478.94 | $69,854.72 |
| 24 | $69,854.72 | $2,633.58 | $8,824.38 | $61,030.32 |
| 25 | $61,030.32 | $2,274.07 | $9,183.89 | $51,846.41 |
| 26 | $51,846.41 | $1,899.88 | $9,558.08 | $42,288.33 |
| 27 | $42,288.33 | $1,510.50 | $9,947.46 | $32,340.84 |
| 28 | $32,340.84 | $1,105.19 | $10,352.77 | $21,988.08 |
| 29 | $21,988.08 | $683.42 | $10,774.54 | $11,213.53 |
| 30 | $11,213.53 | $244.45 | $11,213.51 | $0.00 |
| Total | $143,739.01 |
A few things you will quickly note about the numbers:
– Your total Interest payment will be $143,739.01
– You will have paid a total of $343,739.01 for your $200,000 loan at the end of the 30-year term
– You will pay more in Annual Interest than Annual Principal until Year 14 of the 30-year term
– In Year 14, you will pay $5,538.86 in Interest and $5,919.10 in Principal
In a nutshell, 58% ($200,000/$343,739.01) of your total loan payments made over 30 years will go to Equity in your home. The other 42% will go to Interest.
That’s a significant amount of your paycheque going to interest alone. It is very important to understand these numbers before you purchase a home.
Banks Love Mortgages!
The payments are front-loaded with interest.
You pay $143,739.01 interest on a $200,000 loan.
You have to wait until Year 14 for your Principal payments to be larger than your Interest payments.
These huge interest payments are the reason why banks love the mortgage business. It is hugely profitable for banks.
How Many Homeowners Wait Until Year 14?
You can see in the above example why the elder population holds most of the homeownership wealth in most countries. It takes passing the first 14 years (almost half the loan term) for the homeowner to begin building real equity or wealth in the home. This time favours elder homeowners.
It takes time to build wealth in a home.
But the truth is, according to real estate records, most people do not remain in the same home for 14 years. The average home is sold after 4.7 years. Thus, most homeowners do not benefit from time.
As such, most homeowners pay interest on their homes and own little equity.
Thus homeowners rely predominantly on market forces that they do not control to increase the value of their homes in order to build equity in their homes. They hope that the home value rises significantly higher than the outstanding loan balance on the home. A significant rise in home prices is needed to accumulate significant equity (minus loan) in a home prior to that 14-year mark.
Most homeowners actually simply sell their homes before the 14-year mark and move in to another home and mortgage.
Even when borrowers refinance their mortgages, that is, lower their interest rate, they simply take on a new 30-year loan and extend the mortgage length. Then, they still sell the home before the 14-year mark is reached and move in to another home and mortgage.