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When someone buys a home, they will usually need to borrow money from a lender to help finance the purchase. The terms of a loan are written into a document called a “note”. The note specifies how much the home buyer borrowed from the lender, the interest rate, the term or length of the loan and the monthly payment. The note itself is only a promise to repay the money that has been borrowed. With only a note, the lender has no collateral for the borrowed money.
So, if the borrower failed to pay the monthly payment as described in the note, the lender has no recourse.The mortgage gives the lender recourse since it outlines the terms contained in the note along with providing the lender a legal ability to take the property if the borrower fails to follow the terms. The mortgage is the lenders assurance that the note will be repaid by someone.
Looking at an example of a mortgage using numbers to illustrate.
If a person borrowed $100,000 at 5% interest for 30 years, their monthly payment to the lender would be $640.99. When the borrower makes their first payment, the amount of the payment includes interest on the unpaid balance of the loan, and the remainder of the payment get applied against the principal balance, reducing the principal balance. This process is called amortization.
Since the amount borrowed was $100,000, the amount of interest due for the first month is calculated by multiplying the unpaid amount of $100,000 by the monthly interest rate. The monthly interest rate is 1/12 of the annual interest rate of 5% (.05 ÷ 12 =0.004166667%). If we take 0.00416667 percent of $100,000 we get $416.67.
This means that out of the first monthly payment of $640.99, $416.67 is interest. The remaining $120.15 is applied toward the unpaid principal balance reducing the loan amount to $99,879.85. The remaining balance is what the borrower is charged interest on for the next month.
As the unpaid balance decreases each month, the amount of interest charged decreases and more of the monthly payment is applied to reduce the unpaid balance.
Why is this information important to understand with regards to wealth creation? Well, the faster a mortgage is retired, the faster someone is positioned to build wealth. Imagine not having rent or a mortgage to consider in your budget because you own your home. How does not having a housing cost in your budget change your financial life? Roughly 35% of income goes toward housing expenses…What would you do with 35% more money?
Planning is everything when is comes wealth creation. Most people are not going to be a pro athlete, win the lottery for some insane amount of money, be a successful entertainer, or some wildly successful business mogul swimming with the “Sharks”; however, with good basic understanding of how money works, the rule of 72, how taxes impact wealth creation, the value of money over time, how interest works, an understanding of how to create a business and drive value for customers – you”ll have a better chance of reaching your financial wealth destination.
All of the wealth creation tools are available to everyone. The key is constructing a meaningful plan, taking action, using your head, and seeking out people who “are” where you want to go and asking them to share their path to success. This is just a starting point so be persistent in your purpose.
No one does anything worthwhile without the help of others. Personal wealth creation begins with you!
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