>failing to take into account that only a tiny fraction of the mortgage payment actually becomes equity.
What percentage of a mortgage payment actually gets converted into equity?
(coming from a genuinely curious person who has never owned a house)
What percentage of a mortgage payment actually gets converted into equity?
(coming from a genuinely curious person who has never owned a house)
If you do the math, a typical 30-year mortgage will cost you twice the actual cost of paying cash for a home, so roughly 50% of your payment actually gets converted into equity, assuming your home value was static over the term. This is why people often advise new homeowners to make an extra principal-only payment as often as possible at the beginning of the loan: to cut down the eventual amount of interest you'll end up paying.
That's what I've done with my mortgage. I've been lucky to be in a position to make frequent principal-only payments and should be able to cut a 30-year mortgage to 15-ish or so, saving a metric grundle of cash in the process. Given the nature of the conversation happening around this thread, I suppose I should state my reasons for trading away job-seeking flexibility: I LOVE that eventually, I'll have a roof and four walls independent of my employment situation.
Expand the basement? Sure! Get a bunch of dogs? Why not! Commit to getting to know the neighbors? Sounds great. All while not having to worry about a landlord doing whatever they want at the end of a lease.
It's a very rewarding thing. Is it for everyone? Absolutely not, much in the same way having kids or getting married isn't for everyone either. But for me, there is a lot of value in the actual ownership.
It's funny that two out of the three things you said are additional expenses that the house enables.
Of course, we aren't disputing the emotional value of owning a home. We're just saying that it's a poor financial decision most of the time.
Those same two things may also be valuable to the owner, regardless of expense. Expand my basement so I have room to continue working on the hobby I love? Sounds good.
In a typical 30yr mortgage, you will make 360 monthly (roughly equal) payments. If your mortgage payment is $1000/mo, payment #1 will be approximately $950 interest and $50 principal. Payment #360 will be ~ $50 interest and $950 principal.
Most people move every five or six years (historical, might not be true with current RE market), so they complete about 20% of their total mortgage schedule. However, because of this ramped apportionment, most people still owe the lender much more than 80% of their initial purchase price.
The first time I did the math on this, I thought I had discovered a huge consumer-hostile scam. But actually it's quite reasonable -- mortgages are designed to keep payments equal over the term of the loan, so there's really no other way to do it.
It was quite the slam-dunk easy decision to make where I live (San Francisco), considering how hot the rental market is. My house rents for $1k more than the monthly mortgage!
The reason mortgages front load the interest is not to victimize borrowers (that's just a pleasant side effect) but because in the early days of the loan, you are using more of the lender's money. You pay it back slowly, but you pay interest in each payment on the amount that you're using at that point in the term.
So payment #1, you pay interest on ~100% of the loan. Plus a little extra to reduce your principal. Next payment is interest on ~99.8% (100% minus 1/360th), plus a little extra (more than last time) for principal reduction so that the payments total the same amount. On and on til payment #360.
If you're paying 40% principal on payment #1, by my math, either your effective interest rate is variable over the term, or you're choosing to overpay the invoice (applying the excess to principal -- which makes a huge difference in the early years).
I'm surprised the economics of buying work out so well in SF these days. When I left, it was the other way around. Interest rates help a lot. Congrats on the house!
The economics of buying vs renting has changed a great deal since I moved here. 5 years ago, buying was rather questionable. I took advantage of "cheap" rents to save up for buying a house when it finally became a buyer's market. Now rents have nearly doubled, but housing prices haven't gone up proportionately.
However, blindly following advice on renter-ship is as bad as blindly following advices on homeownership. Every situation is different, and you should do your math per your specific situation.
Unless you make lots of extra payments you gather equity very slowly. The break even interest vs equity per year point is at the half way point.
Here's a calculator I whipped up: http://instacalc.com/1737 (adjust the numbers as you need; this is a side project of mine).