Loan Payments, Points, and Amortization

Loans payments, points, and amortization are math calculations normally completed by the lender, but it’s important for you to know what these terms mean and how the formulas work. After all, you’re the one who might be coughing up $750,000 to pay back a $200,000 loan if you don’t know what the points and interest rates are.

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Points are a percentage of a loan collected upfront. If the lender is asking for 2 points, that’s 2% of the total value of the loan. Two percent of a $300,000 loan is $300,000 times .02 or $6,000. Every one point charged by the lender raises the annual interest rate charged on a loan by 1/8%. The annual interest rate goes up one full percentage point for every eight points charged upfront by the lender.

Loans secured by a home mortgage often include an application fee. Application fees can vary from $100 to several thousand dollars. Always, always, always remember that all lenders are NOT the same. Shop around! Some lenders charge no application fee and no upfront points. Avoiding these two items will cut thousands from the final costs of purchasing a new home.

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In purchasing a house you might not hear the word amortization but all lenders use it. The calculations are all done by the lender’s software so all you can see is the figure representing your monthly house payment. If you want to get technical, amortization is the method used to pay off a loan using a fixed payment schedule. This usually means making monthly payments to the lender.

Amortization can best be illustrated with an actual example. Let’s say you take out a $300,00 loan to be amortized at 7% over 30 years, and your monthly payment is $1.330.62. How much of your first monthly payment is principal and how much is interest? By asking the lender, you determine that $1,166.66 of your payment is for interest. From your payment of $1,330.62 subtract the interest of $1,166.66, which leaves $163.96. Of your $1,330.62 payment, only $163.96 went toward the principal. That means after your first payment, you still owe $299,836.04 of the original $300,000.

In our course Buying A Home, the first lesson is Don’t Buy a Home. If you haven’t already checked out the course, you might want to. The above example of amortization demonstrates exactly why you should never buy a home if you plan on moving with a few years. If you try to sell the house two years later, you’ll probably owe almost as much as you purchased it for. After owning a home for two years and making 24 monthly payments, you’ve probably paid only a few thousand toward the principal of the loan.

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