A critical tool for gauging the health of the real economy is the housing market. When the job market is strong and people have capital to spend to move the economy activity in the housing market will also grow. If the job market is week and people are overburdened with too much leverage the housing market will first suffer then feed on itself. This is due to the loss of equity from falling values, tight lending requirements from funding institutions that reduces the pool of potential buyers in the market, and lack of capital required as collateral by these institutions in order to get funding to purchase a property.

There is more to the housing market than just buying and selling homes. There’s construction, building permits, existing home inventory, new construction inventory, and foreclosure backlog that can also be measured to gauge how well the economy is doing. A core practice for being financially aware is to follow the housing market. Understanding this market will help you when it comes to making decisions in managing your finances. In addition, you should definitely know this market if you intend to purchase a property which is classically known as the biggest purchase you will ever make. Here are few important things you need to know about a mortgage.

Interest

When a bank issues credit to you to finance a property it is creating currency that never existed and your debt becomes an asset on the banks balance sheet. Not only do you have to pay back the currency that was created out of thin air. You also have to pay back more currency in the form of interest to the bank. That interest is profit for the bank who is taking the risk of issuing credit to you. Let’s do some basic math on a simple mortgage scenario.

You want to want to purchase a property for $250,000.00 so you go to the local bank to get a loan. The bank wants 20 percent down as collateral for the credit they are about to give you to finance the home. So you give the bank $50,000.00 that you worked a long time to save and the bank creates $200,000.00 in currency as a credit for you to buy the property. In exchange for the credit the bank decides to charge you 3 percent interest over the life of the loan in addition to the principle (the $200,000.00 created out of thin air) and that’s 30 years. Your payment for 30 years is $843.21 and that include principle and interest, but the devil is in the details of the loan.

The total interest paid over the life of the 30 year loan is $103,554.90. This is more than a 50 percent gain for the bank as your total payment for a $250,000.00 property is $353,554.90. In the first 5 years of you making $843.21 monthly payments to the bank $22585.95 went to reducing your $200,000.00 debt and $28,849.74 went to the bank as profit it made off of you. It is amazing to see how much of our wealth we as people give to banks in exchange for currency that’s created out of thin air. Think about this, 57 percent of all you paid over the 5 years went straight into the bank’s pocket.

You may try to rationalize this with the fact that you get a government handout in the form of a tax write-off or the property will increase in value over time. Congress is already debating on weather they should end your ability to write-off mortgage interest and I think we now know there are holes in that theory of home price appreciation.  You should really ask yourself is it worth it to enslave yourself for 30 years to bank for the privilege of owning a piece of property or should you be strategic by saving your wealth and paying cash. If you are able to be strategic you will preserve a lot of wealth in the process.

The best gifts you can give your kids as parents are love, a debt free education, and the opportunity to purchase a home without having to enslave themselves to a financial institution. The other thing to remember is that there is a right time and a wrong time to buy. By knowing and understanding the market you will be able to make the right decision at the right time.

SM21

Amortization table for $200,000.00 borrowed on May 20, 2012