How many people know their credit card’s interest rate? How many people know how much they have paid in credit card fees (interest)?
How many homeowners know how much they have paid to banks in interest on their mortgages?
It has always been our opinion to pay off our debts- credit cards, loans, or mortgages- as aggressively as possible. This action can save thousands of dollars, and that is what I hope this post will show in an interactive way.
INTEREST = BAD
I am not talking about a savings account collecting interest. In this post I am focusing on credit cards, which are like little loans, and mortgages, which are like big loans with a house at stake. In these situations interest is what the consumer, YOU, are handing over to the bank. Interest is NOT in your interest here.
I HAVE BECOME A BANK
This week, my husband and I signed to close the sale of our former house under a “Contract to Sale”. It wasn’t ideal. We hoped to collect the amount of our home and be able to use it for well, things. The buyers, however, had some pretty hard times we learned, and this situation would give these new homeowners a much needed home.
I didn’t know what a Contract to Sale was, so let me tell you. It is similar to a Rent to Own Contract where the buyer(s) pay monthly amounts to rent the property, but these payments go towards the cost of buying the home. When the tenant(s) are ready to buy, the remaining balance is calculated and a sale and closing process occurs at that time.
For the Contract to Sale, the idea is the same, BUT the deed and title move to the buyers at the beginning. The closing of the sale happens at the beginning. We, as the sellers are providing them ownership of the home, BUT we hold ownership over them because they owe us for it.
This is exactly what a mortgage is with a bank. When buyers take out a loan from a bank to buy a home, the banks say- “Okay. You can gain ownership of it. We will cover the cost, but we get the house if you do not pay us the agreed amounts back. AND we are also going to collect interest on it.”
So, I have become a bank. Despite feeling pretty uncomfortable about it, I am a bank. I will be keeping an Amortization Schedule with them until they can take out a mortgage with a real bank. They will be making monthly payments to me, and I will be dividing that up in two places:
1.) Some of that goes to us for our service of lending them money to buy our home (the interest)
2.) Some of that goes to reducing the balance on the home’s cost (the principal).
The thing that I want to really emphasize here is the tendency to overlook the interest. As I stated, the monthly payments they make do not just chip right at the principal of the home. A portion of the monthly payments in this or ANY MORTGAGE go to the bank and is a loss to the home buyer. Me, knowing the ugly truth about interest, makes me feel kind of uneasy being a banker in our Contract to Sale situation.
MY CHALLENGE: FREE YOURSELF FROM THE BANK
Coming from someone who is a bank now, I say FREE yourself from the fees of the bank and the likes of me. I actually did an assignment concerning this topic for a precalculus class about 5 years ago. I felt many of my students walked away with eyes opened to the evils of paying minimum amounts.
I have two activities consisting of questions I feel everyone should know if they are credit card users or homeowners, OR looking to become new homeowners. I also have a couple of Google Spreadsheets. Once can be used to calculate credit card charges and one I found which is an Amortization calculator.
It takes sitting down sometimes to really see how much interest, or EXTRA money people are paying for these “services”. I hope you all don’t think it is too much math. I thought maybe this could be another “date night” activity like I had concerning finances and protocols for sharing goals. Maybe even after these activities, your goals and personal finance sheets could be adjusted.
You can free yourself from the bank when you pay off your monthly balances on your credit card. You only free yourself from loans and mortgages when you pay it in full. Pay it as quickly as possible to minimize the amount of interest you are paying.
Activity 1: The Charges of Having a Credit Card (read more)
First, let me illustrate what paying minimum payments looks like. I took a rough estimate on monthly family spending that could be placed on a members credit card. This $4000 figure is very rough. See how the interest in calculated in Figure A: One Cycle Interest Charge below by following the amounts and equations. I also have a link to a semi- interactive spreadsheet where you can play around with your own numbers. I only did four billing cycles of paying minimum payments with this average of $4000 per month spending. The blocks can easily be copied an pasted.
Figure A: One Cycle Interest Charge
After going through the figures, try using your own numbers in the spreadsheet by copying and pasting into another spreadsheet.
Here are some questions you will need answered to customize this activity to you:
1.) What is the Annual Percentage Rate on your credit card? (It is found at the bottom of your billed or online monthly statement; 19.24% is an average rate!!!!)
2.) What is the current monthly balance on it?
3.) When is it due?
4.) How much are you planning on paying on the balance?
Put these in and see the interest you are accruing. Note if you do not pay off your minimum payments, not only will you have built interest, the card companies also put on LATE FEES.
MOSTLY keep in mind, if you pay your whole balance off at the end of the cycle, the card companies charge NO interest. Credit card companies are flourishing. They bank on people paying minimum or just portions on their balance, so they can collect the ridiculous interest.
Activity 2: Amortization Schedules-The Charges For Having a Mortgage
When you borrow money to buy a home, within AALLLL of the paperwork will be an amortization schedule. An amortization schedule is a table of the payments made to the lender and shows how the payment is divided to the INTEREST and to the PRINCIPAL (balance of the home).
I am a real estate agent now, and one thing I would tell new home buyers to look for when they are searching for lenders (banks most of the time) is to ask- ARE THERE ANY PENALTIES FOR PAYING OFF THE LOAN FASTER THAN THE FINANCED TIME? This question as well as the interest rate would be the big things to consider.
Paying off the home mortgage as quickly as possible reduces the interest. Again, the principal is the amount owed on the home. At the beginning the principal is at its highest. Since the interest is calculated as a percentage of the principal, at first, MOST of the monthly payments will go toward the INTEREST. Have I mentioned to get that principal down as quickly as possible!??
Here are the questions to consider:
1.) What mortgage amount did you take out?
2.) What is the interest rate the lender/bank offered on the mortgage?
3.) Over how many years will the lender finance the mortgage? (This is usually 15 years or 30 years)
4.) What is your monthly payment amount?
5.) Go to this Amortization Schedule and enter in your values. Then, mess around with the payments. Make larger payments, and see how it effects the “Total Interest Paid” in the top right box. I did a mortgage for $66,000, with an interest rate of 5.5%, financed for 30 years. If you did the suggested payment that the bank will tell you based on these figures, the TOTAL INTEREST PAID IS ABOUT $68,900. You just paid double for the house. See Figure B: Amortization Schedule.
Figure B: Amortization Schedule
Well, thanks for reading this really mathy lecture to ease my conscience of being a bank. Please ask any questions! I’d love to help free people from their banks.
Just to let you know what is coming up… I am excited to be a guest post on the Ray Journey next week on Saturday, everyone!! I will be sharing some information on our experiences flipping homes. It is kind of perfect timing too because this month marks our first year at being in our “new” home. We bought it as a fixer upper, so I will share the before and after pictures with you next week as well.
Thanks for reading.