COPYRIGHTED MATERIAL
Amortization. Most home loans have a term of 30 years. On the first day of every month, the homeowner makes their monthly mortgage payment. Over the years, the loan balance is paid down. The process of paying down a mortgage is called amortization. As the loan amortizes, less and less is owed on it. As the home is increasingly freed up from debt, the homeowner’s equity builds. The effect is like putting that money into savings. If the homeowner stays in the home for 30 years and pays off the loan, they own their home free and clear of debt. If they sell before the mortgage is fully repaid, the home loan is paid off through the sales proceeds and the rest of the money goes to the seller. Reflect on Learning: Go to a mortgage calculator such as mortgagecalculator.org to explore how to calculate a monthly mortgage payment and observe how amortization works. Assume that the homeowner above paid $175,000 for their home. They put 20% down and have a loan of $140,000 at a rate of 4%. What is their monthly mortgage payment? The payment is $673.00. Check out an amortization schedule. Note that in the early years of a mortgage, payments consist of mostly interest; but in the later years, more and more of the principal pays down the loan. That is why building equity through amortization requires that the owner keep the property for a number of years. Sweat Equity. Another way homeowners build equity is by working hard to make improvements such as painting, decorating, landscaping, updating, or improving the functionality of the property . This is called sweat equity . If you’re willing to give up your weekends, spend a lot of time in home improvement stores and work with your hands, you can add to the value of your property just by working to improve it. Reflect on Learning: An appreciation calculator will tell you how much a home will be worth at a given rate of appreciation and time. Explore appreciation with mortgagecalculator.org. The Mortgage Deduction. The federal government encourages homeownership because, historically, it has enabled people to build wealth and financial stability. To foster homeownership, homeowners are given a special IRS tax deduction called the mortgage deduction . It allows the owner of a property to deduct from their income all of the interest paid on their mortgage each year. Reducing taxable income is an important financial benefit because it puts the taxpayer in a lower income tax bracket which reduces the amount of income taxes they have to pay. PRODUCT PREVIEW Appreciation in Action In 1963, the average price of a home in the U.S. was $19,300. In 2015, the average price was $355,500. Fin Lit Trivia Fin Lit Trivia Fin Lit Trivia Appreciation. A home is an investment, and investments often appreciate , meaning they increase in value over time . Many homeowners have been able to build significant equity through appreciation. Currently, the average annual appreciation rate for home values in the U.S. is about 3%. Keep in mind this is an average . In areas of the country where housing is in high demand, the appreciation rates can be very high — often up to 20%. In other areas where there are too many homes and not enough people to buy them, or where there is an economic downturn, homes can depreciate , which means they can lose value .
THE 21st CENTURY STUDENT’S GUIDE TO FINANCIAL LITERACY 157
Made with FlippingBook - Online catalogs