Twenty Percent Rule

Finance allah shmoop what is a mortgage amortization schedule and

how does it work All right we'll think of mortgages

Is the jet i warrior of bonds Their special government

kissed even there not just a typical bond like a

car loan or alone for that new turbocharged skateboard you

had your eye on Mortgages carry one key special feature

that's an integral part of what has made america great

The interest payments on bonds for mortgages are tax deductible

So if you're paying fifteen hundred bucks a month and

mortgage payments and the highest or a marginal tax rate

that you pays forty percent with federal and state taxes

combined and most of that fifteen hundred boxes interest which

is the case in the early years of pain off

these things than the fifteen hundred dollars payment feels like

only about nine hundred bucks on an after tax basis

like forty percent of fifteen hundred and six hundred dollars

You subtracted from the fifteen hundred there And you get

sweet luscious deduction meaning that it's say well ninety five

percent plus of that fifteen hundred dollars for interest than

in that year You'd have twelve payments of fifteen hundred

dollars or total payments made to the bank of eighteen

grand That's round a bit here and say that seventeen

grand of it was interest i you paid down a

thousand bucks of principle And if you earned ninety thousand

bucks that year with the tax rate of say thirty

percent federal in ten percent state on earnings from seventy

thousand to one hundred grand well then on the amount

over seventy grand iaea get to that ninety grand of

your full year earnings Well you would take off or

deduct seventeen thousand dollars from the ninety and pay taxes

on earnings of just seventy three thousand box The government

lets you deduct the interest payments against your taxable earnings

as if in fact you had never had those taxable

earnings in the first place They essentially give you a

discount on the net after taxes interest rate your paying

in the form of a give back on your taxes

So let's dive into a mortgage amortization schedule and amortization

here just refers to the pace at which you reduce

the principle you owe over time and we have this

pretty chart to help illustrate that So you finally bought

that four hundred fifty thousand dollar home It's an almost

literal shoebox in palo alto but well its home or

it will be You went to the bank and got

alone for three hundred fifty thousand dollars After putting one

hundred grand down your loan is a thirty year loan

They offer them and all kinds of flavors like fifteen

year loans interest only loans or reverse mortgages A whole

different kettle of fish there Well in this case note

the monthly payments Each payment is the same two thousand

forty two dollars fifty cents a month and note that

the first payment is three hundred sixty five bucks in

change in principle paydown See right there and sixteen seventy

seven and change in interest So after that first month

the principal owed is three hundred fifty thousand minus the

three hundred sixty five dollars in principle you paid down

or three hundred forty nine thousand six hundred thirty five

dollars ish So if you go on about your business

for fifteen years well the ratio of principle to interest

looks dramatically different at this point Well again on the

same payment of two Oh for two point five o

the principal covered by that payment is eight hundred sixty

box and the interest on the loan is now down

to about eleven eighty three And note that after fifteen

years thie amount owed on the home is down from

three hundred fifty thousand Right That's the loan you originally

took out Two Now a principal set of about two

hundred forty six thousand like you've paid down over one

hundred grand So you're still making the same monthly payment

of two oh four to fifty But on lee eleven

eighty three of it the interest portion is deductible So

from an after tax perspective that mortgage gets a bit

more expensive each year as the principal has paid down

in a higher portion of the mortgage payment then comprises

principal pay down which is not deductible versus interest payments

Which are so then what do things look like near

the end Different We're talking about the end of the

mortgage period Yeah well that last payment is again in

two o four to fifty but it comprises two o

three Two of principle pay down and yes about in

box of interest That's it So then after thirty years

you'll have paid a total interest amount of over three

hundred eighty five grand That's just an interest So think

about that number It's more than the entire amount of

the loan you originally took out So you have wow

two oh four to fifty a month Tone your dream

home That's it right No not at all Remember you

have insurance and depending on what kind you get and

i'll figure around three hundred bucks a month toe over

a grand And then you have real estate taxes and

figure about one and a half percent of the purchase

price which then goes up about the rate of inflation

overtime So on this four hundred fifty thousand dollar home

that's real estate taxes of about sixty sir seven fifty

ish year about five fifty a month And for many

first time home buyers you have to get pm i

or private mortgage insurance That's kind of safety cushion for

the bank not for you and is laid on is

an additional expense When the homeowner has put on ly

a small amount down as a down payment that is

the homeowner has to pay some percentage of alone They've

taken out In addition to that base interest of say

six deductible percent like you have to pay an extra

one non deductible percent in pm i until they can

get the bank to agree that their loan to value

ratio is less than eighty percent That's kind of like

the bank's magic number or set another way that the

equity they have in the home is mohr than twenty

percent of its value Or so why like why would

the bank do this other than to make it yet

more profit from you mr or mrs vulnerable mortgage taker

But the reality is that if the bank ever does

have to foreclose on the house and then sell it

and spend a fortune on legal bills evicting you let

alone dealing with all the bad press it gets extremists

all excited about regulating the bank's further you know because

of course it was the bank's fault that you were

drunk and got fired from your job and spent your

dough on fast cars and even faster robots So banks

make risky small down payment makers take out cushion insurance

in case well this ever happened so that they aren't

the ones left owning a house they never signed up

to buy Yeah Hey at least there's a white picket 00:06:00.835 --> [endTime] fence Go for it No