Home Loan Offers

Just the other day I received a mailer by Liberty Mutual Marketing.  It was quite clever.  Came addressed to me in one of those envelopes that you have to tear the sides off.  I have seen these before, but this one had important confidential material on the front preceded by the words county of ******.  Ok, looked official so I opened it.

Ended up being a mortgage offer for fixed rate of .385% for ten years with a rate of 6.75% after the fixed period. 

Is this home loan offer a good deal?  On the surface it sounds great.  A fixed interest rate of .385% for 10-years followed by a 6.75% thereafter would be an incredible deal.

Here is why:

First a nice chart to see how much a Payment would be for a typical 30-year loan for various interest rates and loan amounts:

 

Home Loan Chart

For comparison, lets say you loan is $300K at 6% on a normal 30-year home loan.  This Chart gives you a payment of $1,799 per month.

The assumptions for this comparison: 

Your loan is 300K at 6% with 360 payments left (30-years).

You continue to pay $1,799 per month.

With that out of the way we can start to compare:

 

Here is what you need to know:

  1. Your payment ($1,799)
  2. Amortization Schedule for new loan (See below on how to create one)
  3. Amortization for old loan
  4. Interest rate new loan (fixed .385% for 10-years and 6.75% after).
  5. Interest rate old loan (fixed 6% for 30-years).
  6. Loan amount ($300,000)

Using your amortization schedule, you will find on the old loan you pay $166,000 in interest over the first 10-years vs. $7,600 in interest on the new loan.  The new loan allows you to put $159K more towards principle in the first 10 years. The only thing left to check is how the 6.75% costs you for the remaining 20-years.  The answer is not much.  The promotional rate brought down the principle so much that the increase in interest does not come close to offsetting the impact of being able to pay down principle quickly.

 

Remember, more interest is paid up front on conventional home loans, so paying principle down quickly in the front has a very large impact.

 

With the loan structured as is, you would pay your home off in 180 months Vs. 360 with the old loan even though the interest is 6% vs. 6.75%.  This loan would be a no brainer when compared to a conventional 30-year fixed at 6% and making payments of $1,799 per month.

 

So what is the catch with the loan?  After reviewing the fine print, interest in the first 10-years is .385% with deferred interest of 5.6% during the ten year period.  Is this still a good deal?  That is a bit harder to calculate and I will cover in a new post in the near future. 

Tip

You should never switch to a loan with a short term fixed percentage rate that adjusts to a variable or some other option after the fixed period if you can not afford the payment change.  Or, if you can afford the change, it is critical that you do a detailed comparison of the loan to see how the loan compares to a traditional fixed loan. 

Many of these promotional loans are good deals if you can continue to pay higher payments with the goal to lower your principle balance during the promotional interest period.  If you exercise the lower payment options many of these loans come with, you can actually add life to your loan, fail to make future payments when it rises to the right level, or simply end up paying more than a conventional 30-year fixed loan.

 

How to compare:  Ask an accountant or tax professional, search the internet, or create schedules to compare loans.

 

Amortization Schedule 

The basic way to create an amortization schedule is to use Microsoft Excel or any spreadsheet program. 

Don’t have spreadsheet experience?  No problem, I found this tool that creates one for you:  http://www.amortization-calc.com/

It is nice to understand how they work, so go through the steps below to see if you can match the one created by the site above.

 

1.  First take your balance of the loan.

2.  Create a line for each month you have left in your loan. 

3.  Next, take your interest rate and divide it by 12.

4.  Multiply that number times your balance.  This is the interest portion of your current payment.

 

5.  Now to complete the schedule simply deduct the portion of your payment that is not interest from your balance and start the process over on the next line.

Now that you know the interest for each month you know how much of your payment goes to interest and how much goes to the balance of the loan. 

Here is a snapshot of one for a 300K loan with a payment of $1,799 at 6% interest.

 loanamt.jpg

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