Banks sell ‘term loans’ where the loan is arranged in a way so the bank takes their profit on the lending in the first ten years or so of the loan term (i.e. 20, 25, 30-year term, etc.) and leaves you to slog it out for the second half after they’ve recouped most of their interest and reduced their risk.
The term loan is a wolf dressed as a golden retriever. Speak to anyone who’s 65 with a hefty mortgage and I can tell you they feel like they’ve been bitten.
Imagine Compound Interest working against you.
But, if you think about it, borrowers allow themselves to be ripped off by not paying enough attention to the product they’re buying. We just go out and buy a few hundred grand of money and don’t have any plan in place to repay it.
People who accumulate wealth and financial security do things a bit differently.
they’re no smarter than the rest of us necessarily, they just pay a shitload more attention to their money – earning it, saving and investing it. Growing it.
They know how the game works because they decided to learn how to play. Most people sit on the sidelines wearing the team guernsey eating pies, drinking beer and getting fat while they boo and hiss at how unfair the game is. While the rich folks are on the pitch, socks up, lean, fit, sweaty, taking risks and playing the game and giving the other team a hiding.
The term loan is a tricky product that the banks have devised to allow the borrower to amortise the cost of a property over most of their working life. They run up to 30 or even 35-years at the outset but really, most of us refinance every four years or so and often extend the term. So, the term can be anywhere up to… your whole life.
You thought you were pretty clever to get such a bargain because you talked the owner of the property down $50,000 off the asking price, but just wait until the bank takes that off you in the next three years with the interest they charge you on the borrowing. Who’s the clever one now?
How term loans work
Want to see something AMAZING? Introducing one of the very few products available in the world today that quite literally allows the seller (banks) to print money.
The 25 or 30-year term loan allows lenders to lend money in a way that sets borrowers up to lose right from the start.
Yep, I said that. Why? Because they do. Let me explain. When you borrow money for 30 years, the lender, bank or credit union structures the loan and the repayments from the outset so that the majority of your repayment for the first half of the loan is interest.
This is why when you borrow, for the first five or 10 years it seems like paying off the loan will take an eternity. And it will. That’s what you signed up for if you didn’t have a plan to crush the mortgage in, say, 15 years. It’s a pretty clever trick, and basically puts the principle of compound interest into play against you.
What happens is the more principal you owe, e.g. in the early years of the loan, more interest is calculated and therefore the more interest you must pay, and on it goes until you’ve broken the back of the principal which is not really until 20 years into the loan, when you’ve paid as much principal as you’ve paid interest. You better believe it.
And the sad thing is, we allow banks to get the better of us because most of the population are financially illiterate and don’t want to learn. If you’re reading and understanding this, then you’re much closer than most people in this country to understanding how to manage your money to win.
Often overlooked is that most borrowers refinance every four years or so, and guess what? They extend the term back to 25 or 30-years to reduce the repayments. The result? The loan is never paid off, they spend a lifetime in debt, never investing, never getting ahead and retire without a nest egg. It’s a grim, but common situation I see.
Here’s what happens when $780,000 is borrowed at a tiny 3.5% over a 30-year loan term:
- A borrower will pay more than $480,000 in interest (or bank profit) which is 62% of the $780,000 borrowed.
- It will cost 2.14 x more to borrow over 30 years versus 15.
- In the first five years, 62% of the total amount you repay will be interest.
- In the first 10 years, 58% of your repayment is bank profit.
The borrower will, quite literally be spinning their wheels going nowhere for the first 15 years.
People with money don’t have mortgages for 30 years. It’s one of the many reasons why they have money – they’re not perpetually servicing a loan, ie. giving their money to someone else! When they borrow, they smash the loan out in the fastest time possible
In comparison, here’s what happens when $780,000 is borrowed at a tiny 3.5% over a 15-year loan term:
- A borrower will pay $224,000 interest which is 29% of the total or less than half the money a 30-year borrower will waste.
- They will save $256,000 which is a shitload of money. I can see you smiling there. Yes you are.
- In the first five years, only 35% of the total repayment is interest.
- In the first 10 years, only 29% of the total repayment is interest.
By year 15, the smart people have paid the loan out and they’ve paid an average of only 22% interest.
The term of the loan will make the biggest difference to the total amount you repay to the lender and the amount you can invest to build a nest egg and financial security. Think of the wealth you could create if instead of servicing a loan for 30 years, you made it your goal to pay the loan off in 15 – 20 years, then begin investing and making money.
I don’t blame you if you think this is slightly overwhelming and “how the hell will I manage this and all the shit I’ve got going on in my life right now”.
That’s why we’re here. Get a Professional Mortgage Broker to help you borrow the money, then make a plan to repay the loan in as short a time as you possibly can. Request a call with me or one of the team =>HERE.
Here’s to YOUR Financial Security,
Brodie Brown
Professional Mortgage Broker