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Do You Understand Real Estate Loan Formulas?

What does the real estate loan formula actually include…

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

All of them are interrelated and changing one of them is likely to change the others, although not as often as you might think. There are some clear rules about it, but it is better not to rely too much on them. Before you start thinking about a specific real estate loan, you should spend some time learning the variables with a financial calculator.

Expression: the period used to calculate the loan repayment is often the same as the maturity period, ie. when the final installment is due. Remember, however, that in some cases the loan term is much shorter than the loan period (eg balloon mortgages). The standard term for a real estate mortgage is 30 years, although in the case of amortized loans you can choose a term from 10 to 40 years. Generally, the longer the period, the lower the monthly payment, although the change is much smaller than you might expect.

Interest rate: it is the amount of money that the loan lender will give you to pay you. It is usually a percentage of the amount you borrow. The amount is charged each payment term, but it is usually quoted on an annual basis. The interest rate of 6% is usually increased by 12% by 0.5% (in the case of monthly payments). The lower the interest rate, the less you have to pay. The effect is greater in the case of long-term loans.

Basic: this term can mean either (1) the portion of the transaction used to reduce the balance or (2) the entire amount being financed. In general, the principal (1) must be higher than the interest rate, otherwise you will end up with negative amortization (your loan will grow even as you pay the interest). The higher the principal (1) the lower the final value.

Final score: this is the total amount 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 the loan has been paid off in full. Remember that the lower the final price you want to get, the more you will pay.

Payment: your monthly (rarely quarterly) payment. This is an important variable that determines whether or not you can ultimately pay off a loan.

A word of caution: although it is possible to work out the formula on a financial calculator, it is very difficult to do it on paper, even if you were good at Math in college. An online financial calculator is much faster and doesn’t make mistakes.

Remember, when choosing a home loan for yourself, you need to know all five variables – only then will you be able to determine what you can really afford. It’s often actually better to go for a higher monthly payment if it means a lower final price. On the other hand, you may want to extend your loan (longer term and higher final value) to get more money for a lower installment… The number of possibilities are many, but you should know what they really are if you bin will benefit from them.

Good luck with your real estate adventures.

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