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what a mortgage is. I think most of us have atleast a general sense of it, but even better than that,actually go into the numbers and understand a little bitof what you are actually doing when you're paying amortgage, what it's made up of and how much of it is interest versus how much of it isactually paying down the loan.
Let's just start with a little example. Let's say that thereis a house that I like. Let's say that that is the house that I would like to purchase. It has a price tag of, let's say that I need to pay $500,000 to buy that house.
This is the seller ofthe house right here. And they have a mustache. That's the seller of the house. I would like to buy it. I would like to buy thehouse. This is me right here. And I've been able tosave up $125,000 dollars. I've been able to save up$125,000 but I would really like to live in that house so I go to a bank. I go to a bank, let me geta good color for a bank.
That is the bank right there. And I say, "Mr. Bank, can you lend me "the rest of the amountI need for that house?" Which is essentially $375,000. I'm putting 25% down.This number right here, that is 25% of $500,000. So I ask the bank, "Can Ihave a loan for the balance? Can I have $375,000 loan?" And the bank says, "Sure.You seem like a nice guy "with a good job whohas good credit rating.
"I will give you the loan but while you're paying off the loan you can'thave the title of that house. "We have to have that title of the house "and once you pay off the loan, "we're going to give youthe title of the house." What's gonna happen here isthe loan is gonna go to me, so it's $375,000. $375,000 loan. Then I can go and buy the house. I'm gonna give the total $500,000, $500,000 to the seller of the house, and I'll actually moveinto the house myself, assuming I'm using itfor my own residence. But the title of the house, the document that says who actually owns the house. This is the home title. This is the title of the house. Home title.
It will not go to me.It will go to the bank. The home title will go from the seller, or maybe even the seller's bank, because maybe they haven'tpaid off their mortgage. It will go to the bankthat I'm borrowing from. This transferring of thetitle to secure a loan. When I say "secure aloan," I'm saying I need to give something to thelender in case I don't pay back the loan or if I just disappear. This is the security right here. That is technically what a mortgage is.
This pledging of the titleas the security for the loan, that's what a mortgage is. It actually comes from old French. Mort means dead, andthe gage means pledge. I'm 100% sure I'm mispronouncing it, but it comes from dead pledge because I'm pledging itnow but that pledge will eventually die once I pay off the loan. Once I pay off the loan thispledge of the title to the bank will die and it will come back to me. That's why it's called adead pledge, or a mortgage.
And probably because itcomes from old French is the reason we don't saymort-gage, we say mortgage. But anyway, this is alittle bit technical, but normally when peoplerefer to a mortgage they're really referringto the loan itself. They're really referringto the mortgage loan. What I want to do inthe rest of this video is use a screenshot froma spreadsheet I made to actually show you the math, or actually show you what yourmortgage payment is going to.
thenyou'll see all the files there and you can just download this file if you want to play with it. What it does here, in thiskind of dark brown color, these are the assumptionsthat you can input and then you can change thesecells in your spreadsheet without breaking the whole spreadsheet. Here I've assumed a 5.5% interest rate.
I'm buying a $500,000 home. It's a 25% down payment, that's the $125,000 that I had saved up, that I talked about right over there. And then the loan amount. Well, I have 125, I'mgonna have to borrow 375, it calculates it for us. And then I'm gonna get apretty plain vanilla loan. This is gonna be a 30 year. When I say term in years, thisis how long the loan is for. So 30 years.
It's gonna be a 30 yearfixed-rate mortgage. Fixed rate, which means theinterest rate won't change. We'll talk about that a little bit. This 5.5% that I'm payingon the money that I borrowed will not change over thecourse of the 30 years. We will see that the amount I've borrowed changes as I pay down some of the loan.
This little tax rate that I have here, this is to actually figureout what is the tax savings of the interest deduction on my loan. We'll talk about that in a second, you can ignore it for now. Then these other thingsthat aren't in brown, you shouldn't mess with these if you actually do open up thespreadsheet yourself. These are automatically calculated. This right here is amonthly interest rate. So it's literally theannual interest rate, 5.5%, divided by 12. And most mortgage loans arecompounded on a monthly basis so at the end of every monththey see how much money you owe and they will charge you this much interest on that for the month.
Now given all of these assumptions, there's a little bit ofbehind-the-scenes math, and in a future video Imight actually show you how to calculate what theactual mortgage payment is. It's actually a prettyinteresting problem. But for a $500,000 loan--Well, a $500,000 house, a $375,000 loan over 30 yearsat a 5.5% interest rate, my mortgage payment isgoing to be roughly $2,100. Right when I bought the house, I want to introduce alittle bit of vocabulary, and we've talked about thisin some of the other videos.
There's a asset in questionright here, it's called a house. And we're assuming it's worth $500,000. We're assuming it's worth$500,000. That is an asset. It's an asset because itgives you future benefit; The future benefit ofbeing able to live in it. Now there's a liabilityagainst that asset, that's the mortgage loan. That's a $375,000 liability. $375,000 loan or debt. If this was your balance sheet, if this was all of your assetsand this is all of your debt, and you were essentiallyto sell the assets and pay off the debt, if you sell the house you get the title, you can get the money, thenyou pay it back to the bank.
Well actually, it doesn'tnecessarily go into that order but I won't get too technical. But if you were to unwindthis transaction immediately after doing it, then youwould have a $500,000 house, you'd pay off your $375,000 in debt, and you would get, inyour pocket, $125,000, which is exactly what youroriginal down payment was. But this is your equity. The reason why I'm pointing it out now is, in this video I'm notgonna assume anything about the house price,whether it goes up or down, we're assuming it's constant.
But you could not assume it's constant and play with thespreadsheet a little bit. But I'm introducing thisbecause as we pay down the debt this number's going to get smaller. So this number is getting smaller. Let's say at some pointthis is only 300,000. Then my equity is going to get bigger. So you could do equity ishow much value you have after you pay off the debt for your house. If you were to sell thehouse, pay off the debt, what do you have left over for yourself. This is the real wealth in thehouse, this is what you own. Wealth in house, or theactual what the owner has. What I've done here is-- Actually before I get tothe chart let me actually show you how I calculate the chart. I do this over the course of30 years, and it goes by month. So you can imagine that there's actually 360 rows here in the actual spreadsheet, and you'll see that ifyou go and open it up.
But I just want to show you what I did. On month 0, which I don't showhere, you borrow $375,000. Now, over the course of that month they're going to charge you .46% interest. Remember, that was 5.5% divided by 12. .46% interest on $375,000 is $1,718.75. So I haven't made anymortgage payments yet. I've borrowed 375,000. This much interest essentiallygot built up on top of that, it got accrued. So now before I've paidany of my payments, instead of owing 375,000 atthe end of the first month, I owe $376,718. Now, I'm a good guy, I'm notgonna default on my mortgage so I make that first mortgage payment that we calculated right over here. After I make that paymentthen I'm essentially, what's my loan balanceafter making that payment? Well, this was before making the payment, so you subtract the payment from it.
This is my loan balance after the payment. Now this right here, thelittle asterisk here, this is my equity now. So remember, I startedwith $125,000 of equity. After paying one loan balance,after my first payment, I now have $125,410 in equity, so my equity has gone up by exactly $410. Now you're probably saying,"Gee. I made a $2,000 payment, "roughly a $2,000 payment, "and my equity only went up by $410 "Shouldn't this debthave gone down by $2,000 "and my equity have gone up by $2,000?" And the answer is no because you had to pay all of this interest. So at the very beginning, your payment, your $2,000 payment, is mostly interest. Only $410 of it is principal.
So as your loan balance goes down you're going to pay less interest here, so each of your payments are going to be more weighted towards principal, and less weighted towards interest. And then to figure out the next line, this interest accrued right here, I took your loan balanceexiting the last month, multiplied that times .46%. You get this new interest accrued. This is your new pre-payment balance. I pay my mortgage again.
This is my new loan balance. And notice, already by monthtwo, $2 more went to principal. and $2 less went to interest. And over the course of 360months you're going to see that it's an actual, sizable difference, and that's what thischart shows us right here. This is the interestand principal portions of our mortgage payment. So this entire heightright here, this is-- Let me scroll down a little bit. This is by month. So thisentire height, you notice, this is exactly our mortgagepayment, this $2,129. Now, on that very first monthyou saw that of my $2,100, only $400 of it, this is the $400. Only $400 of it went toactually pay down the principal, the actual loan amount. The rest of it went to pay down interest, the interest for that month. Most of it went for theinterest of the month.
But as I start paying down the loan, as the loan balance getssmaller and smaller, each of my payments, there'sless interest to pay. Let me do a better color than that. There's less interest. We goout here, this is month 198, over there that last monththere was less interest, so more of my $2,100 actuallygoes to pay off the loan until we get all the way to month 360.
