In a previous post, I talked about how I discovered that I was paying 95% interest on a 2nd mortgage I had on my home. Somebody asked a very good question: How are you paying 95% interest? You have a 11.5% loan. I thought it might be a good idea to follow-up with a better post explaining how it works.
It’s called compound interest. When you get a loan, they charge you interest. If you get a long loan, like a 30-year loan, you make a lot of payments, and you pay a lot of interest. Over time, the interest compounds. Let me show you how compound interest works on the calculator.
1. Go to the Homes in Order mortgage calculator and enter loan details.
2. Don’t stop there!!! Now scroll down to Amortization Table and see how your payment is structured.
Step 3. Digest.
I was paying over 95% interest. Isn’t that amazing? But I wasn’t the only one. All that most people care about is how much their monthly payment will be. That’s what I was thinking when I got my mortgage. I had an 80/20 mortgage structure, and this loan represented the 20% portion. It was cheaper than paying PMI insurance. But I certainly didn’t understand the concept. At the time, I had cash in the bank that I could have just paid off this mortgage, but I thought, like most others, that “a mortgage is cheap money.”
Not so cheap.
I didn’t discover this until about payment 16. Through payment 16, I had paid a total of $7,647.44 in interest, and only $274.89 in interest. That’s what it’s like to pay 96% interest. I paid $7,647.44 in interest when I had cash in the bank. That’s an expensive lesson on compound interest! I hope you learn from my mistakes.
Nice graphics.