compound interest is where the bank say's its 3.5% interest but if you do the math you're paying 180% for a house. I don't have any idea how that became acceptable/the norm.
The interest in it's simplest form is just a value appreciation of the time value of money [1]. Would you rather have $100 today, or $100 next month? How about $100 today vs $102 next month? Still rather in the today camp? How about $105 next month? That is the interest. It is the value derivative of having the money 'now' vs having the money 'later'.
Where things can get scammy is in the complex type of credit products on offer (tying in all sorts of opaque references to things presented as neutral which are far from), and how things are communicated to the borrower.
Tip: If you are considering a loan, always ask for a full repayment plan showing you which payments are due each month, and the resulting reduction in the amount due (your payment first covers the interest accrued in that month, and only after that covers principal reduction). If there are variables in the loans formula, ask for simulations that cover the most likely evolution scenario, as well as the extremes. Every financial institution has such a payment plan calculator. Long ago I have written one which afaik is still in use today in a non-trivial financial services company.
[1] https://www.investopedia.com/terms/t/timevalueofmoney.asp
You shouldn't have to spend an hour learning how the bank are gnna screw you.
As stated above, money has a 'time value'. Getting $100 today has a different value to you than getting $100 somewhere in the future. So to know whether a deal is interesting, I do not just have to know how much I will be getting back in return for my investment, but when. Getting back $180 as a single lump sum payment in a year is different than getting 12 monthly payments of $15 each month for the next year, even though in both cases you will have payed me back $180 looking back.
The interest rate the bank quotes, in your example 2%, is the percentage amount by which your outstanding IOU to them will be increased at the end of the month, before you make your monthly payment.
Now this was an example of a simple fixed interest rate. In practice there are unlimited kinds of formulas that can have variable interest rates over time tied too other things, capped or uncapped, and even then that is just one of the things that goes into a payments plan. So unless you have nailed down all the other factors, comparing just interest percentage A with interest percentage B, typically in the final haggle, tells you little.
This is why I advice always looking at the series of monthly payments that you will have to make over the duration of the loan repayment, and compare these with the series of monthly payments due under a competing proposal.
Banks will screw you over in more ways than you can imagine, but quoting a compound interest rate as opposed to a total amount repaid at the end of contract (which btw is often much longer than the repayment period or even unlimited in time but that is another story) isn't where it is at.
If I take out a £100000 loan with an APR of 2% and pay it back in full at the end of the first year, then the total amount I pay back is £102000. Apart from any early repayment charges, the original total term is irrelevant.
When taking out such a large sum, over such a duration for buying your home, the total amount to repay is not the important aspect. It's not like taking out a loan to buy a car or a holiday. You don't have the option of choosing between buying now with a loan, or saving up for a few more months or years to buy without one.
Affordability of the regular repayments over the duration of the loan is the key thing.
There is absolutely no way I would take out a loan of that size with fixed interest in the way you describe. It would be far too expensive, and give the bank too much power.
I'm relying on the fact that I can make large overpayments in order to own my home outright halfway through the original term. That couldn't happen without an annual interest rate. In fact, the most logical thing to do in that situation is to stretch the loan out for as long as possible, so that inflation makes your repayments cheaper.
For a rough example -
Imagine you bought a house for £100K 5 years ago, the interest is such that over 20 years it will cost £150K total (e.g. 3.5% over 25 years).
You have probably paid about 30K, taking about £15K off the capital.
You sell the house for the same amount you bought it. With annual interest, you owe the bank £85K, you give them that, and use the spare 15K for your next home.
With a fixed price, you still owe the bank £120K. You give them the £100K you got from selling the house, and you somehow have to find £20K to pay them the rest.
The bank is giving you $X to buy the house. You’re paying off a piece of it each month (your mortgage payment). Part of that goes to the interest on the loan, the rest goes to principal. The interest each month is based upon on the remaining principal. That means your payment starts off being mostly interest and gradually becomes mostly paying off principal.
You could say, “But I can just save the full price and then buy the house with no interest!”. Sure you could. But you’re forgetting that you’re living in the house (or renting it out...) while you’re paying it off.
If you paid $0 on principal your first year, the interest would be $100,000x0.05=$5000
Make it monthly: $5000/12=$416.67 rounded up to $417
On an amortization schedule, the fixed payment is calculated at $537, with $120 going to principal and $417 going to interest on your first payment. Exactly what you would expect to pay. The interest isn't front loaded, it's just the actual accrued interest of what you have borrowed.
When you pay the $120 in principal on your first payment, your debt reduces to $99,880. $99,880x0.05/12=$416 rounded. Therefore, your next payment, still at the fixed rate of $537 is now paying $121 in principal, and $416 in interest.
In short, when you have a large debt, you pay larger interest, when you have a smaller debt, you pay smaller interest. This isn't exploitation, just mathematics.
$536.82x12x30=$193,255.20 Total($193,255.20)-Principal($100,000)=TotalInterest($93,255.20) give or take a dollar.
And so according to your desire, you'd want them to say it is a 93% mortgage.
The reason they don't is that interest rates and compounding are typically done annually. You also have the ability to make extra payments sometimes, which can pay it down faster. The faster you pay the debt, the less interest you pay.
For instance, if you win the lotto, receive a life insurance payout, or inheritance, etc and pay off the loan within the first year, it's no longer a 93% mortgage but a 5% one.
To me, it makes more sense to say, you owe $100,000 your first year, or $98,398 your second year, and that you'll be paying 5% interest over that year.
But that depends entirely upon how long you take to repay it. If you pay the loan aggressively up front, you pay less; if you make minimum payments for as long as possible, you pay more.
Your point seems to be basically that because you can’t do the maths, the mortgage is misleading. That is maybe a fair argument in some cases with financial products. Investment banks are notorious for obscuring the true cost of deals with complicated maths. However this doesn’t seem like a case of that. If the interest rate is 5% APR and you are free to pay it off as fast or as slowly as you like within some bounds, for example, it is absolutely essential that you understand what a 5% rate means to know how the mortgage works.
edit: not to mention that 5% is already a contrived figure not representative of how the interest is actually applied, designed to make it easier for you to understand what you’re charged. Your interest is probably calculated monthly or daily, not yearly. They could present you a nice hypothetical yearly figure, or a nice just-as-hypothetical 93% three-year figure. What’s the difference? Neither of them are real. Your interest is charged monthly, so they’re equally fake and misleading.
That's only one kind of mortgage though - for a while there were mortgages available in the UK where you only payed the interest on the principal but you also payed into a separate saving scheme with the idea that when the latter matured it would pay off the former.
No idea if these are still available, but for a while in the early 1990s you used to get a very hard sell on them - we had one for a five years or so. In reality they are a terrible idea as you are paying interest on a non-decreasing principal which is a shockingly bad idea and then there is the risk of the saving scheme performance as well.
Edit: Of course you got a hard sell on them as they were clearly a terrible idea from the borrowers perspective but were far more profitable than a normal mortgage for the lender.
That said, the interest is a great write off for a landlord, especially if they are personally the originator of the loan to their holding company.
Not just that, but definitely do the math on the monthly payments.
In my case (in Chicago), my minimum monthly mortgage payment was half the monthly rent I had been paying, for a significantly nicer and larger place. Just had to get past the down-payment hurdle.
If the initial loan was $400k on a $500k house, then yeah it sucks that I've payed you $1.1M, a clear overpayment, but I wont be sad because I'm coming out ahead by about $1.5M.
In reality, loans come with minimum payments, so you can't come out quite so far ahead. What this all means is if you can do something better with your money, (e.g. market tracker at 7% on a 3.5% loan), then just pay the minimum and do that better thing with the rest. If you can't (e.g. market tracker at 7% on an 8% loan), then pay it down as fast as you can, or don't take it in the first place unless there are other factors.
In the markets where the money did end up, like the stocks and bonds markets, inflation ran rampant with NASDAQ and S&P history shows.
And neither S&P nor NASDAQ had anything resembling rampant gains, BTW:
S&P: https://www.macrotrends.net/2526/sp-500-historical-annual-re...
NASDAQ: https://www.macrotrends.net/1320/nasdaq-historical-chart (you have to click on the "by year" tab).
In neither of these charts a person unaware of QE could identify a trend.
Inflation as in the rise in price of a basket of goods is generally used in reference to the consumer price index, but can also be used in reference to stocks, and baskets of those such as the indices.
If the prices of assets rise, that is appreciation. If stocks or houses appreciate, you can sell them and profit: Your purchasing power rises. If consumables experience inflation, you can not sell them for a profit: They are either immaterial, like services, or can rot, like food. This isn't pedantry, these are different concepts.