Buying real estate is definitely one of the best investments you can make. Generally its quite safe, and the returns could be very appealing, but there is also a lot of work to consider, and a few risks and traps that, if neglected, could ruin you.
One of those traps is the bank. If you’re like most people, you probably don’t walk around with 1,000,000 dollars in cash to splash out on a house, so you most likely have to go the bank route, (unless you have a rich uncle who gives you everything you want).
I have nothing against banks or bankers, in fact I’d like to be one, but a lot of people don’t realize that its all just a big game with certain rules that need to be followed. How many times have you heard people say things like ‘the bank screwed me over’, or ‘those bankers are all thieves’. I know quite a few people that think like this, to them it makes perfect sense, and if you’d listen to their story it might make some sense to you too. But what they don’t understand are the rules of the game, in fact they probably don’t even know its a game, once this concept sets in its not long before you start thinking that maybe you can win the game.
To win this game the first thing you need is to know how it works. When you apply for a mortgage loan from a bank, generally they will give you a 20-30 year repayment loan. A good way to get an idea of what your monthly premiums will be on a 30 year mortgage is by calculating 1 percent of the loan, so if you’re asking for a $1,000,000 loan, your monthly premiums will probably be around 10,000 dollars a month (this can easily vary depending on the interest rate).
Now lets say that the interest rate is 13 percent (thats about what it is in SA right now). The way the premiums are calculated based on the figures I’ve given so far will be something like this:
- The first thing that you need to understand is that the interest is calculated each month, I’m not talking about the interest rates (although that can also fluctuate), I’m talking about the interest that needs to be paid each month, it will be calculated each month based on the rate.
- The interest is calculated per annum, so 13 percent of $1,000,000 is $130,000. The interest that needs to be paid on the first month will be $130,000 divided by 12 which is about $10,850.
- I wrote a small program to calculate all this for me but I don’t have it with me, so I’ll just give rough guesses. Basically you will pay about $10,835 interest in the first month, so your whole premiums will be something like $11,200.
- If your whole monthly premium is $11,200 and your interest on the first month is $10,850 that means you’re only putting about $365 to pay back your 1,000,000 dollar loan. Scary, they really are thieves.
- What happens is that you spend the first 10 years of your happy home life paying the interest alone to the bank, eventually as the loan gets paid back ever so slowly, your interest starts going down, and soon you’re paying less interest and putting more money towards the actual loan, this creates a snowball effect until the loan is completely paid.
- But if you do the math you’ll find that at the end of 30 years you will have paid about 3 times the price of the house. Its still a pretty good investment if you’ve picked the right house and stuck around for 30 years. But most of us don’t want that, generally you want to sell the house after 5 or so years, but with a deal like this there’s a good chance that you’ll still have most of the loan to pay back, you’ve been throwing away a lot of money in interest to the bank, and unless you’ve really picked a winner, the value of the house hasn’t gone up enough to pay for all the expenses so far.
So how does knowing all this help you beat the banks at their own game? Well, the next time you decide to buy a house or some real estate, make a commitment to pay an extra 1,000 dollars on top of the premiums. So if your premiums are $11,200 per month, pay $12,200. If you do this you’ll find that you can cut down the loan years to something more in the region of 10 years instead of 30. And instead of paying 3 times the initial value of the house you could easily end up paying a fraction of the value in interest.
With this knowledge suddenly your investment could be very profitable again.
Simon
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Filed under: Money and Finances by Simon Rodrigues
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