Mortgages

To truly understand real estate, you have to understand the "power of the bank." A mortgage is what makes real estate different from almost any other investment because it allows you to control a huge asset with only a small amount of your own money.

Mortgages: The Power of "Other People's Money"

A mortgage is a special type of long-term loan used specifically to buy property. Most people do not have hundreds of thousands of dollars in cash to buy a house upfront. A mortgage allows you to buy the home now and pay for it slowly over 15 or 30 years.

The Magic of "Leverage"

Real estate is famous for "leverage." This means using a small amount of your money (the Down Payment) to control a very expensive asset.

  • If you want to buy $100,000 worth of Bitcoin, you usually need $100,000.

  • If you want to buy a $100,000 house, the bank might let you do it with just $3,500 or $20,000. The bank provides the rest, but you get to keep all the profit if the house value goes up.

The Anatomy of a Mortgage

To be fully informed, you need to know the four parts that make up your monthly "house payment." Investors use the acronym P.I.T.I.

  1. Principal: The actual bit of the loan you are paying back. If you borrowed $200,000, every dollar of principal you pay brings that number down.

  2. Interest: The "rent" you pay to the bank for letting you use their money. This is a percentage of the loan.

  3. Taxes: Local governments charge property taxes to pay for schools and roads. The bank often collects this for you as part of your monthly bill.

  4. Insurance: You must have homeowners insurance to protect the house from fire or damage. The bank requires this because the house is the "collateral" for their loan.

Essential Facts

1. The 20% Rule (PMI)

If you put down less than 20% of the home's price, the bank gets nervous. They will require you to pay for Private Mortgage Insurance (PMI). This is an extra monthly fee that protects the bank, not you. Most investors try to reach 20% equity as fast as possible to cancel this fee.

2. Fixed-Rate vs. ARM

  • Fixed-Rate: Your interest rate never changes. If you get a 6% rate today, it stays 6% for all 30 years. This is the "safe" choice.

  • ARM (Adjustable-Rate Mortgage): Your rate is low for a few years but can "adjust" (go up) later. This can be dangerous if interest rates skyrocket.

3. Amortization: The Interest Trap

In the beginning of a mortgage, almost all of your monthly payment goes toward Interest, and very little goes toward the Principal. As the years go by, this flips.

  • Fact: On a 30-year mortgage, you might end up paying the bank back double what you originally borrowed because of interest!

4. Foreclosure: The Risk

A mortgage is a "secured" loan. This means the house is the guarantee. If you stop making your payments, the bank can take the house back through a legal process called Foreclosure. This is why "Cash Flow" (making sure you have enough money coming in) is so important in real estate.

Strategy: How to "Beat" the Bank

Many smart investors make one extra payment per year or pay a little extra principal every month. Because of the way interest is calculated, doing this can shave 5 to 7 years off a 30-year mortgage and save you tens of thousands of dollars.