Most banks tend to offer a 30-year mortgage, but in other cases there is availability of a 15-year mortgage. Wouldn’t it be easier if banks offer 15-year mortgages so that way they can get their money back faster? That’s basically the question we are answering today.
We’re going to talk about mortgages. Why do banks prefer to give you a 30-year mortgage instead of a 15-year one? Banks are in the business of making money. They don’t want to take your house away, they do not want to leave you homeless or to leave you on the street. They are in the business of making money.
For that reason, they plan things accordingly so that they can create a win-win situation; a win-win situation for you. Why? Because they want to make sure you can pay for the mortgage, and at the same time, a win-win situation for them so that way they can continue to make money off of you.
Why do banks give you a 30-year mortgage?
One reason is that you get lower monthly payments. That way banks will keep getting their money and that way you can afford to pay the bank. Why? Because it’s not the same to have a $2,000 mortgage as opposed to having a $1,000 mortgage. Typically, when you get a 15-year mortgage, because you’re condensing the time to half of what a 30-year mortgage would be, that means that your monthly payments will be higher. Sometimes that can be unsustainable for some families. For that reason, a 30-year mortgage tends to be the preferred option because the banks know that there’s a higher likelihood of you to afford the monthly payments as opposed to a shorter mortgage.
What does amortization allow you to do? Let’s say you have a 30-year mortgage and you pay during the first half (15 years) the highest amount of interest as possible, and then after you get through half of the mortgage, the mortgage interest starts minimizing and getting smaller and smaller.
Historically and statistically, people tend to perform well in their mortgages in the first five to seven years. Because they’re excited, they have a new home, and they want to keep that home. You want to make sure you are paying the bank. Banks know that.
Banks know that you don’t want to let go of your home, so they work it out in a way so that they can get the most money out of you in the event something happens in the future. If they are getting a 15-year mortgage, that means they’re making less interest off of you upfront.
Once again: They’re in the business of making money. As time passes, you are building equity. Yes, you’re putting more money towards interest, but you continue to build equity in your home. That’s the second reason why they want to do that.
Banks get to make more money off of you on interest
It is not the same to charge somebody a 30-year worth of interest as opposed to 15-year worth of interest. The bank knows it, now you know it, and that’s why they prefer the longer mortgage because they get to make money off of you in the long run.
What happens if you default? If you default it doesn’t have to be so dramatic. If you default or get bored of the bank, that means that you’re reducing the time that you’re going to be with that bank. If this happens there will be a higher likelihood that you will no longer be with them after the fifth or the seven year.
How do you go to another bank? By refinancing. Let’s say you got an offer in the mail seven years later, and this bank is offering you a mortgage of refinancing for 1% less. 1% might sound very little, but then when you add it up to the remaining 23 years in your mortgage, it does add up to a lot of money. The bank actually knows that. If you do get bored, then they have more reasons to push for a 30-year mortgage because they want to get the most money out of you from the very start of the mortgage.
If you default, not so good on you, but if you do get bored and you decide to refinance, it will work out for you because now you will get a lower rate and you will be saving more money in interest.
The bank can also get bored of you
If they get bored of you they can sell your mortgage. They can actually find another investor out there in the market and they could sell your mortgage. They sell whatever amount of money you owe to them. For example, you have a mortgage and you still owe $180,000. The bank will say, “I’m going to find an investor and I’m going to sell this to them at $170,000,” That means a $10,000 discount.
Why would the bank do that? What they do is that they package this mortgage – your mortgage in this case – in a way that it looks very enticing to the new investor. New investor will come in, buy that at a $10,000 discount, take the work off of this bank, and then chase you to collect the payments. That’s how banks would automatically get $170,000 in their accounts.
Like that, they get liquid cash so they can go out and lend the money to new people. New people who are looking to get homes, new people who are looking to use that capital, and the bank will charge them a certain percentage in origination fees. They’re going to charge them plenty of interest upfront for the next five to seven years.
Whatever amount of money that they “lost” at the discounted price, they will be making it back with that strategy. How? By applying the amortization, and also by charging people loan origination fees.
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