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Total Cost Of Credit vs Monthly Payments
By David Wilding
I read a press release the other day which points to the fact we need
to be very careful with our finances. The subject of the release was
home mortgages. A company was announcing the availability of
40 year mortgages for its customers. The stated purpose was to
lower the monthly payments to make buying a home more affordable.
Whenever I hear the phrase “more affordable”, I put my hand on my
wallet because the attempt to empty it will begin any moment. Almost
never is that phrase used in relation to the total cost of financing. It is
always used in reference to the size of the monthly payment, as in this
example.
Let's see what it really means. I did the math. A mortgage for a
$100,000 home at 6% for 30 years would have a monthly payment
of about $600 for principal and interest. You would pay about
$216,000 over the life of the loan of which $116,000 would be
interest.
A mortgage on that same home for 40 years would be at 6.25%,
with a monthly payment of $565. The payments over the life of
the loan would total about $271,200 and $171,200 of the total
would be interest.
The forty year mortgage has a higher interest rate (usually
between 25 and 50 percent) because the lender has his
money at risk for a longer time (Lenders are well aware that
time is money. You should be as aware).
This higher rate coupled with the extra ten years of the loan, has
the borrower paying 47% more interest, or $55,000 more over the
life of the loan. Even with a lower payment that supposedly makes
it more affordable to purchase that home. Sounds like a pretty
good deal for the lender.
Another problem the borrower faces is building equity much
more slowly in the beginning of the loan. The extra interest
expense paid for the extended length of the loan prevents equity
from building up quickly. All of this for a monthly payment that
is only $35 less.
You need to think in terms of overall cost and not just monthly
payments. The total cost is what you will give back to your
creditors. The focus on the monthly payment takes attention
away from the total amount to be repaid. You need to look at
this with any indebtedness, car payments, personal loans, credit
cards: figure the total cost, not just what you pay each month.
You'll begin to hear more about these loans I'm sure. Think long
and hard before you lengthen your indebtedness. The goal is to
become debt free and to do it as fast as possible. Advise your
families and friends to do the same.
(c) 2004 David Wilding
About the Author
David Wilding has for the last ten years worked with groups and individuals to help rid them of personal debt. Visit his site http://www.debtattack.com for other ideas to take care of your debt.
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