What’s More Important, The Total Interest Paid Or The Interest Rate?
Do you ever ask yourself that question? If you have a mortgage, when you look at your annual interest paid on your 1099 do you see anywhere on the form your interest rate? So, if your annual interest paid was $14,000 for the year, would it matter if the rate was 2% or 8%? Actual answer is maybe.
When you are looking at your mortgage rate you should also consider looking at the interest you are paying. Most mortgage loans in the United States, unlike most of the world, charge interest on your mortgage differently. They are what I like to call “Front End Loaded.” What that means is that the majority of the interest you pay is in the first 5-7 Years. Let me give you an example.
Loan Amount | $400,000 |
Rate | 3.5% |
Term | 30 years |
Total Principal and Interest Payment | $1796.18 |
Principal Portion | $629.51 |
Interest Portion | $1,166.67 |
When you make your first payment, they will take the principal portion and reduce your Loan Amount:
Original Balance | $400,000 |
Principal Payment | -$629.51 |
New Balance | $399,370.49 |
They then re-amortize your loan on the New Balance for 29Years & 11 Months.
So your new Principal is | $631.35 |
and your new Interest is | $1164.83 |
They then do the same process as on your first payment. This process continues till the home is paid off.
If you were to pay continually for 30 years of this process, you would pay $174,567.26 in scheduled interest.
That seems like a lot of interest to pay at 3.5%. That means for every dollar I give the lender the first
79 cents goes to interest. I made payments of $1796.18 for 123 months.
Also, it will take approximately 123 months of payments to where your Principal Payment is about the same as your Interest Payment.
In that 123 Months, (10 Years +) you will have paid $127,951.07 in interest of the $174,567.26 in total interest.
Now you see why I call it “Front End Loaded.”
There are loans out there that do not work this way. The rest of the world has been using them since 1965. They are Simple Interest Loans. Your interest is charged on a monthly basis by multiplying the balance of the loan by the rate and dividing it by 12. So as your payoff goes down, so does your amount of interest paid. The end result is that you will pay off your home faster without changing you spending habits and all while paying less interest. So, is it more important to know how much interest in dollars you are paying or your interest rate?
Disclosures: NMLS 298191, Regulated by Dora, Equal Credit Lender AZ NMLS MB1021756, WY MBL 4594
