What is an Amortized Loan


What is an Amortized Loan

Posted on Sep 10, 2007 by Paul White

An amortized loan is the type of loans given to home owners.  Each time you make a payment, part of your payment goes towards your principal ( what you owe on your house ) and the rest goes towards interest ( the bank pockets it ).  Normally people think that what they pay would mostly go towards the principal because other types of loans ( personal loans, car loans ) work this way.  These other loans the amount of interest and the amount of principal is the same with each payment.  But wth an amortized loan its changes over time.  In the beginning your payments are almost all interest, and in the end ( 30 years later ) they are almost all principal.  Since the average family is likely to move after 5 years.  They have built very little equity in their home ( asside from the appreciation which is minimal in today's market ). 

When I was 19, I took a c++ programming class.  In this class we were supposed to write a program that would figure the amortization schedule for an amortized loan.  After I had written the program and looked at the numbers, I realized the reality that most americans live in.  If you buy a 150,000 house. Your put nothing down.  And make payments ( 923.58 for 6.25% ) for 30 years.  In the end you have given the bank.  $322,488.80.  Now assuming your house appreciated at an average rate of 1.5% per year. Your homes value is now at $230,997.  In order to break even your home would have to appreciate 2.7% giving your home a value of $324,813.  Even though recently in the past 5 years, interest rates have dropped, allowing buyers to get much more house for the same payment.  This caused a spike in people wanting to upgrade or buy a house for the first time.  Of course since there are only so many homes on the market the additional demand caused home values to appreciate by 20% or more within a single year.  However this is not consistant.  If homes appreciated by that much, either they will depreciate back to a normal value or they will appreciate at a very slow rate.  In order for home values to go up this much, incomes would also have to appreciate.  Since this does not happen. You get a over supply of homes on the market, and fewer buyers available to buy the homes. 

My recommendation is to pay off the house as fast as possible.  Don't buy the most home you can afford.  Buy a home that you could pay off in 5 years or sooner.  While your friends are off buying new cars, and livnig up the bling bling lifestyle via their credit card, you could be working towards owning your house.  Most people don't think this way.  The few that do will get way ahead of the rest.
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