Last week I shared news about interest rates dropping to an historic, all-time low. Before you can understand how epic the rates are, you have to know the basics of a mortgage. Here are the basic parts of a mortgage:
First Trust
Your first trust is the amount on money you are borrowing from the bank. For example, if you are buying a property for $100k and you are able to put down 20% ($20k), your first trust amount would be $80k. Since you have $20k in cash, you only need to borrow the remaining $80k.
Down Payment
As mentioned the down payment is the CASH on hand that you can invest in the property. The minimum down payment required is 3.5%.
Principal & Interest
Once you are approved for your $80k loan and purchase your $100k property, you will being making payments to pay off the loan. A portion of that payment will go towards principal and a portion will go towards interest. The money you pay towards principal goes to actually buying down the loan and in turn building equity in your property. The interest is the fee you must pay in exchange for the bank loaning you the money.
Continuing with the $100k example, if you secure a 30 year loan with a 3% interest rate, your total monthly payment would be $337. For your first month’s payment, $137 would go toward principal and $200 would be paid in interest. This means after one month you would have $20,137 invested in your property (down payment + principal.) $200 would go to the bank as a fee.
Over the course of your loan, the principal vs. interest ration will improve and more of your $337 monthly payment will go towards principal than interest. This makes sense because you are only paying interest on the amount owed to the bank. As your loan becomes smaller, you are paying interest on a smaller overall amount.
Why is the interest rate so important?
The lower your interest rate, the less fees you pay over the course of your loan. Continuing with the $100k example (assuming a 3% interest rate and a 30 year loan,) you will pay roughly $41,000 in interest over 30 years. That’s $41,000 down the drain and NOT invested in your property. If your interest rate was 5%, you would waste over $75,000 in interest payments. That’s a big difference.
So when you think that a few percentage points isn’t a big deal, it really is. Unless you refinance, the interest rate you receive when you secure your loan is the rate you will have over the course of your entire loan.
To sum it up, money is cheap right now and if you have thought seriously about buying a home, now may be a good time to act. If you are short on cash, check out this post which features properties that would qualify for DC’s down payment assistance program.
Photos are from a Shaw two bedroom condo currently listed for $715,000. Click here to more information.
