The Reality Behind the Foreclosures.

Quote from the article " Bank financing is essentially a nationwide monopoly. You go to a bank, pay exorbitant fees to the bank, and get a 30 year loan that is amortized. An amortized loan is designed to pay more interest up front, and more principal at the end. "

I am a little disappointed in the Denver Post editors, this article is full of inaccurate populist statements.

Nationwide monopoly? There were tons of mortgage brokers, many not banks at all. A 30 year loan is not designed to do anything sinister - it is a pure mathematical formula, it was not designed to screw anybody over. I personally think a 15 year is a better choice, but people always have the "give me the lowest payment" mentality. You can also find a 20 or 25 year fixed if you look. I dont believe in variable rate mortgages except for very sophisticated borrowers with lots of money and 20-30% down payment.

I did not see anything mentioned about Fannie/Freddie, tax policy that encourages debt (deduct interest for home equity loans, second mortgages, vacation homes etc.) Gov't policy encouraging more home ownership to low income groups, loans to those with poor credit, low down payment, (FHA). etc. High home prices and desire for more home than people can afford lead to the market creating variable rate loan schemes with "low payment" teases. People could have used their own intelligence too.

Regarding the straight payment loan, whatever that is, anyone can always make regular extra principle payments to shorten the term. Interest on the outstanding principle is a very simple concept, not a tricky amortization scheme to keep you out of gaining equity.

It was an interesting read though, thanks for sharing.

Stay tuned for the next chapter, student loans. Another looming gov't created disaster ripe for a future bail out.

Note: I edited spelling of "principle", thanks. I remember now principal is the head dude in School, and he is your "pal" Thats how I used to remember it before my spelling faded! LOL

Well said Joe. The reason that mortgages are amortized, and not simple interest, loans is for the protection of the lending institution regarding their security and also to give incentive to someone to lend you money for such an extended period of time. By weighting the payments so heavily towards interest at the outset, the person taking the financial risk to lend large amounts of money over extended periods of time is rewarded for the taking of that risk. Their risk is also lowered in the later periods of the term by the increase in percentage of principle paid during that time frame.

In actuality, the low amount of principle repayment in the first 6 years of the 30 year term protects the borrower from the financial costs associated with drastic swings in real estate values shortly after they purchase the home. The financial institution who lent the money is the one most at risk of falling home values in the first 6-10 years of a 30 year note. They will have paid out significantly more money than the current value of the home should values fall and are unable to recoup their investment should the borrower default for any reason, including economic recession or depression resulting in their losing their job. A simple interest scenario would actually have cost more people a lot more of their money when they were unable to meet their mortgage obligations after their company laid them off than they did. Using RL's example, if they defaulted due to the loss of their job in the current economic downturn they would have lost $60K, in addition to their down payment, worth of actual money paid out instead of losing only a portion of that sum. The bank would actually be in a better position because they would have received $60K worth of principle money and have a home that would probably make them whole against the original amount of money lent when it was sold.

The person incurring the debt is rewarded for making the payments on schedule for the extended period of time by ever increasing amounts being accrued in equity and appreciation of value in the real estate. The current amortization schedule would actually serve as a consumer protection if the federal government wasn't in the business of guaranteeing the loans that the lending institution made through federally chartered private corporations such as Fanny and Freddie.

The reason why more interest is paid up front is because the loan balance is higher and the amount of monthly interest on the loan is more. It is just that simple and it is the basis of amortization payments.

Principle * annual interest rate / 12 = the interest due that month. Subtract that from the payment and the left over is what goes toward the principle. Without at least this interest being paid - your debt will actually increase. There is no real life basis in being able to pay more principle up front without covering that month's interest and then paying more on the principle (i.e. larger payments). Then that begs the question - why did a person pay more for a 30 year mortgage if they want to pay off the principle faster - go for the 20 or 15 year loan.

Our current 30 year loan was available without points, at an interest rate comparable to shorter term loans which did require points, which was important at the time of origination. Crunching numbers showed that it was a better deal for us. We pay extra each month, reducing our principal, and God willin' & the creek don't rise, we will still have the house paid off in 10 years. If the creek do rise, we should still be able to afford the minimum payment. It was a matter of deciding whether to keep cash in savings for emergencies, or paying upfront cash to get a very slightly lower interest rate.

(Disclaimer: we're kinda old and have learned much through past experiences. Young borrowers, excited about owning their own home, are not likely to look at every scenario.)

Would you loan your money out for 30 years at 5%?
I sure wouldn't. We just took our loan out for 20 years at 4.75$. Only a little more a month, but 10 years less of payments!

SS109 wrote: Would you loan your money out for 30 years at 5%?
I sure wouldn't. We just took our loan out for 20 years at 4.75$. Only a little more a month, but 10 years less of payments!

Which is why the profit for loaning out the money, the interest, is paid back more swiftly than the principle in the early part of the term in an amortized loan - to give incentive to someone to take the risk of loaning out their money for a 15, 20 or 30 year period of time. Without an incentive to do so, it is likely that no one would be willing to lend out money for such an extended period of time.

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PrintSmith wrote:

SS109 wrote: Would you loan your money out for 30 years at 5%?
I sure wouldn't. We just took our loan out for 20 years at 4.75$. Only a little more a month, but 10 years less of payments!

Which is why the profit for loaning out the money, the interest, is paid back more swiftly than the principle in the early part of the term in an amortized loan - to give incentive to someone to take the risk of loaning out their money for a 15, 20 or 30 year period of time. Without an incentive to do so, it is likely that no one would be willing to lend out money for such an extended period of time.

No. The only item that affects how much interest is paid is the interest due on the principle for that month. Each month you pay the interest for that month. It is straight math, no other reason than % X principle. This is the same reasoning and calculation whether it is a 1 day old loan or the 29th year of a 30 year loan. The incentive is the same, the percent income is the same.