The word mortgage literally means “death contract”, and this somewhat dramatic moniker was used to underscore the severity of the commitment and effect that the mortgage would have upon the debtor. In essence, a mortgage was something that was binding upon the debtor until they died, and thus would last for their entire lifetime.
Some people have suggested that there is a more sinister twist on this definition: claiming that a mortgage will sometimes be the death of a person. At the very least, a mortgage is a major drain on the financial income of the debtor; and if left unchecked, can present severely detrimental implications in the future.
One of the worst mistakes that a debtor can make when it comes to the taking out of a mortgage is to underestimate the power that a % figure has upon them. For example, it is common for many mortgage providers to levy a so-called “arrangement charge” for the provision of the mortgage. The arrangement charge will typically be levied as a percentage of the total value of the mortgage. At first glance, 5% doesn’t sound too daunting.
However, 5% of a $150,000 is going to be $7500; and that is before you have even signed the contract to make the commitment to the deal concrete! Some commercial lenders will offer the prospective borrower a choice of deferring the repayment of the arrangement charge, and instead having the balance of it added to the balance of the mortgage.
From a psychological perspective, many consumers report that they are sorely tempted to take this option, as the luxury of being able to stretch their repayment schedule helps with their short-term solvency and financial liquidity. It also helps to ensure that they are able to deal with more pressing and immediate financial obligations, in addition to being able to maintain a certain standard of living.
However, the reason that this is problematic is due to the nature of compound interest; the financial doctrine whereby the interest owed on a capital sum is then added to the capital sum and that new figure will then generate additional interest.
Consider the following example.
A mortgage of $400,000 has been taken out by a borrower; with an arrangement fee of 5% levied, meaning that this is valued at $20,000. The annual rate of interest for the mortgage is 10% and compound interest is in effect. This means that the debtor would be liable for 10% of $420,000, with steady increases each year thereafter.
Another issue to be aware of is that some lenders will charge additional fees and penalties to borrowers who actually repay their mortgage in a shorter period of time than agreed. The logic behind this, at least, from the lender’s perspective, is to levy as much money as is reasonably possible from the consumer. However, you may find that making an overpayment maybe to your benefit in the long-term; especially if you are bound by the terms of a compound interest based mortgage.
Richard Combellack, Marketing Director of Fine & Country, an award-winning real-estate marketer and an expert when it comes to luxury property for sale.