Mortgages

Hey there, Smart Spotters!

85% of homeowners have no idea what mortgage they should take when buying their first house.

So……..

Today, we're diving into the world of mortgages. We’re going to be exploring two repayment schedules:

🏘 Interest Only Schedule

🏠 Repayment Schedule

Let’s start with Interest Only (The Teaser Phase).

Picture this: You're on a thrilling financial adventure, much like binge-watching your favorite TV series. The "Interest-Only Schedule" is like the teaser phase of the show – it keeps you on the edge of your seat.

During this initial period, your monthly payments are the suspense-building scenes that keep you hooked. You're only paying the interest that accrues on the loan balance, so your payments are lower. It's like paying for a sneak peek of the movie, but the full experience is still a distant dream.

This could be your go-to if you need some extra cash in the short term or if you're an investor planning to sell the property before the interest-only phase ends. But beware of the twist – once this phase is over, your payments will shoot up as you start chipping away at the principal balance. 

🧮 Lets crunch some numbers:

Let's assume you have a loan amount of $100,000 with an annual interest rate of 5%. With an interest-only schedule, your monthly payment would be calculated as follows:

Monthly Interest Payment = (P × R) / 12

= ($100,000 × 0.05) / 12

= $416.67

So, your monthly payment in the interest-only schedule is $416.67. This payment covers only the interest, and the principal balance remains unchanged. Over time, your total interest payments add up, but the loan amount doesn't decrease until you switch to a repayment schedule.

Now, let’s switch gears to the "Repayment Schedule" – this is where the real journey begins. It's like the meaty part of the story where you're not just watching; you're actively participating.

With a repayment schedule, each monthly payment is like a puzzle piece that not only covers interest but also chips away at the principal balance. It's akin to watching your favourite character evolve and grow stronger with each episode. Over time, your loan balance shrinks, and you move closer to financial victory – in this case, paying off the entire loan by the end of the term.

The beauty here is that you're building equity and outright ownership. It's like buying a collectible that gains value over time instead of just getting a sneak peek. Sure, your monthly payments may be higher than with an interest-only plan, but you're building real wealth in the process.

So, the choice is yours: the suspense of lower initial payments followed by a financial plot twist (interest-only) or the rewarding journey of reducing your loan balance month by month (repayment). Each has its allure, and the choice depends on your financial goals and circumstances.

🧮 Let’s crunch some numbers again:

In a repayment schedule, your monthly payment includes both interest and a portion of the principal. The monthly payment is calculated using the formula for a fixed-rate amortizing loan:

Monthly Payment = [P × r(1 + r)^n] / [(1 + r)^n - 1]

Where:

P = Loan amount ($100,000)

r = Monthly interest rate (annual rate divided by 12 months, so 5% / 12 = 0.4167%)

n = Total number of payments (loan term in months)

Let's say you have a 30-year (360 months) fixed-rate mortgage:

Monthly Payment = [$100,000 × 0.004167(1 + 0.4167%)^360] / [(1 + 0.4167%)^360 - 1]

Monthly Payment ≈ $536.82

In this case, your monthly payment in a repayment schedule is approximately $536.82. This payment covers both the interest and reduces the principal balance. Over time, as you make these payments, the principal balance decreases, and you eventually pay off the entire loan by the end of the 30-year term.

The Differences: The Final Battle

Repayment Schedule:

• Opportunity Cost: Choosing a repayment schedule means committing to higher monthly payments that include both interest and principal. The opportunity cost here is that the money used for these higher payments can't be invested elsewhere, potentially in more profitable ventures.

• Risk: Long-term risk is relatively low as you're steadily reducing your loan balance. However, in the short term, those higher monthly payments may strain your cash flow, especially if unexpected expenses or income drops occur.

Interest-Only Schedule:

• Opportunity Cost: Lower monthly payments mean more cash for other investments or expenses, but the opportunity cost is that you're not actively reducing your principal balance, missing out on equity and potential gains.

• Risk: Interest-only schedules bring uncertainty. Changes in interest rates could hike your costs, requiring a large loan payoff or even selling the property during a bearish market, leading to potential losses.

Remember, financial choices are a bit like plot twists in your favourite series – they shape your story. Make the decision that aligns with your goals and financial narrative.

Stay tuned for our next newsletter where we'll dive into the state of the current real estate climate.

Financially yours,

SpotProp