Do You Understand Real Estate Loan Formulas?

Do You Understand Real Estate Loan Formulas?

What the real estate loan formula really involves…

All loans are based on a mathematical formula that determines how much you are going to pay. There are five crucial loan variables including: term, interest rate, principal, final value and payment. These are also the five most important terms you need to know before you apply for any loan.

All of them are interconnected and changing any one of them is likely to change the others, though oftentimes not quite as you would predict. There are some rules of thumb about that, but better not rely on them too much. Before you already start thinking about any specific real estate loan you should use some time learning the variables with a financial calculator.

Term: it is the period used to calculate the loan payment, often the same as the maturity, ie. the time when the last installment is due. Keep in mind though, that in situations the loan maturity is much shorter than the loans term (for example: balloon mortgages). The standard term for a real estate mortgage is 30 years, though in case of amortized loans you can choose a period from 10 to 40 years. Generally the longer the term, the lower the monthly installment, though the change is much smaller than you might expect.

Interest rate: is the amount of money charged by the loan creditor for lending you the money. It is usually a percentage of the sum you borrow. The rate is charged every payment term, but it is customarily quoted on an annual basis. A 6% interest rate is customarily, 12 multiplied by 0.5% (in case of monthly payments). The lower interest rate, the less you have to pay. The effect is greater in case of long-term loans.

Principal: this term can average either (1) the portion of the installment that is used to reduce the balance or (2) the total amount of money being financed. Generally, the principal (1) should be higher than the interest rate, otherwise you will suffer from negative amortization (your debt will grow already though you pay the installment). The higher the principal (1) is the less is the final value.

Final value: this is the total sum you pay for the loan (all installments plus all additional fees). The final value at the end of the mortgage should usually be zero, meaning that the debt has been paid in complete. Keep in mind that the lower final value you want to get, the higher installments you will have to pay.

Payment: your monthly (rarely quarterly) amount due. This important variable determines whether you can ultimately provide a loan or not.

A information of warning: while it is comparatively easy to run the formula on a financial calculator, it is very difficult to do that on paper, already if you were good at Math in the college. An online financial calculator is much faster and doesn’t make mistakes.

Remember, when you choose a real estate loan for yourself, you have to know all five variables – only then will you be able to determine what you can truly buy. Oftentimes it is truly better to go for higher monthly payment if it method lower final value. however, you might want to stretch your loan (longer term and higher final value) to get more money for a low installment… The number of possibilities are immense, but you have to know what they really are if you are going to profit from them.

Good luck with your real estate ventures.

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