BEWARE: The Last House Payment´s Hiding Something

Most homebuyers find out soon enough that very little of their first year´s mortgage payments are applied to the amount they borrowed. But what they don´t know is how much their last payment costs them!

I´ll show you what I mean. On a $240,000 home, assume the buyers have good credit, have saved awhile to buy their home, and make a 20% down payment—the amount that used to be considered normal.

That leaves $200,000 to be financed. They find an attractive 6% interest rate and choose a conventional 30-year fixed mortgage. Their payments are $1200 a month ($1199.11, to be exact).

After about a month of settling into their new home, they receive their first mortgage statement. It shows one payment has already been deducted from their checking account, just as they´d agreed (for a 1/4% lower interest rate). The statement indicates $199.11 of their payment was applied to the mortgage principle. In other words, they´ve paid off a little less than $200 on their $200,000 loan—1/10th of 1%. Five times that much--$1000--went toward the lender´s profit.

As sort of an upfront insurance, the lender reclaims most of the dollar amount of the loan as interest before applying much money to reducing the debt.

By the end of the first full year, as the couple is celebrating their anniversary in their home, they check to see how much their principal payback has increased as they´ve whittled away at the loan month after month. Their statement shows that the bank gratefully acknowledges their donation of $11,933 to its coffers. In addition, $2,456 has been credited to their loan. Not counting their down payment, they´ve purchased 1.2% of the home.

It´s at this point more experienced homebuyers will reassure the newbies that things will change. "It gets better from here on out. More and more of your payments will go to principal," friends say.

While more of each payment is applied to principal, the backside of a mortgage is not as glorious as it may seem. There´s a nasty little secret hiding back there that few people ever consider--a sinister side, if you will.

In the sample mortgage we´re reviewing, the buyers are 18.5 years into paying it off when they reach the so-called halfway point, the month where approximately 50% of a single payment goes to interest and 50% to principal. They have paid in $266,202, of which $80,678 has been applied to principal.

Things are going well, according to the bank´s schedule of repayment. The homebuyers still owe nearly $120,000 on the principal of their house, plus the interest they´ll pay in the remaining 17.5 years of their mortgage. It does begin to look like quite a lot, like an overwhelming undertaking.

Ultimately, I want to focus on the very last payment, the one many folks would consider the most exciting payment of all. The last payment holds a disturbing secret.

In the $200,000 home loan we´re looking at, the last payment is only $1,190.29, about $9 less than the normal monthly payment. Of that, a mere $5.92 is interest. On the surface, one might think, "Oh, only $5.92 interest on the last payment! That´s more like it."

The devil of it is that last payment costs $3,316. The $1184.37 principal paid on the last payment has been owed for 30 years. Therefore interest on it has been paid for 30 years. In fact, it´s the same amount per month that you see in the last payment: $5.92.

Multiply that $5.92 by 12 months a year to see that $71.06 a year has been paid to hold the privilege of paying the last $1184.37 later. The interest on the last payment is not $5.92. It´s $5.92 times 360, or $2131.87…interest. Combined with principal, the last payment on your $200,000 loan at 6% is $3316.24.

That´s why I say you can´t afford it. Yes, you may have enough money. But if you´re comfortable paying 180% interest for purchases, you may not have enough money long!

There are many techniques for reducing your mortgage and avoiding this outrageous interest. I urge you to seek out half a dozen or so, and find one or more that is right for you. You can´t afford 180%!