Interest Rates Are Nothing But Smoke & Mirrors (Mortgages)

The interest rate is just a number. It's just a number that's, you know, the big flashing sign outside the bank to get your attention. Interest rates are what are used to attract money.

What we're going to do is we're going to look at the annual pattern of spending of just an average Canadian household, because we're casting a wide web here. We're talking to many different people from all different walks of life. One way or another, you are going through or have gone through this process. So what does it look like in the house now? What we're looking at is 100% of the dollars that are coming into the house. Where are 100% of those dollars flowing? And how much of that flow is going to the principal and the interest of what you're acquiring, the objectives you want to accomplish? So let's just assume that 20, 20% of the household income is going to vehicle financing. We have housing, so we have to pay for our living expense or our home, whether that's mortgage or rent. Let's assume that it's a mortgage for this example, and we have living expenses. Of course, that's probably our largest expense. Oh, sorry. The housing, you can see is about 30%. Now, if our largest expense is the living costs or gas or groceries, our utility bills, all those kinds of things. So it's about 40% going out the door for that. Now, we know that the average savings rate in Canada is a lot less than 10%. But let's be generous here. Let's assume that 10% is flowing out the door to actually go into savings or investments of some kind. Now we're going to start to discover as we go through this process and we start learning about the difference between interest rates and interest volume. So what we're taught to focus on is the rate. The lower the rate, the better we're doing. But it's all about how the debt is actually compounded. It's all about how that loan is structured and how it's amortized or what have you. And who is setting the rules on how that works? That would be the bank. So this isn't saying that the automobile financing is 5%. It's saying that 5% of your total income that's coming in is flowing away just in interest. For car financing, because of the interest volume. Same with housing. I mean, you're all real estate investors here. We've all seen an amortization schedule. Most of the payment in the early years especially is actually going directly to interest. So the income that you're earning 25% of it just for your mortgage financing could be going directly to interest. Now let's assume that for the living, you know, there's a small chunk here, maybe there's a line of credit or a credit card or something like that that they're servicing. So if we look, we have 5, 25% and 35% the total income coming into the house. 35% of that income is flowing away just in interest volume. So not only are you permanently transferring that 35% away, you're permanently transferring the opportunity to grow that, the growth potential on that money. Now I'm going to expand on this when I talk about interest volume here. I'm going to expand on it by walking through the real truth in lending. So again, real estate investors in Canada, we all kind of have some familiarity about how the mortgage process works and whatnot. But let's really take a deeper dive and take a look at what's actually happening and the real truth in lending. We, in this example, we have a $400,000 home amortized over 25 years. We have an interest rate of 2.92% and that's going to give us a monthly mortgage payment of $1,880.24. Well, let's take a look at what starts to happen. We're going to break this down by principal and interest and take a look at the balance. Now we, we get in our house, we're all excited. Let's maybe it's, maybe it's just a family. They get in the home, they're excited and they're working hard and they're paying off that mortgage. Or even if it's a rental property, your renters are paying for the mortgage, but who's the first to get paid? Where does all that money flow? It flows directly to the bank. And in this example, less than 50% of the payment in the first month actually went to the principal. Because of how the mortgage is structured, we know that that interest is all front end loaded month. Two, we slowly start to chip away. We got about $2 more that went to principal. And after the first year, the same payments flowing in. And $931 still less than 50% is going to the principal and $948, 76 is going directly to interest. So our new balance, after the first year, we bought the $400,000 home, the 388,970. That means that we paid 22,562, 22,562 flowed away. Even though we hit some principal, it's still kind of trapped in the home. So that money's all gone. We've given up the opportunity to grow it. But we paid 22,000, but only 11,000 went to the principal. I know you've experienced this before, maybe when you bought your first home and you're excited because you got your annual mortgage statement and you take a look at it and you go, and your jaw drops like, what is going on? And then if we keep the pattern going here, we go to year three. So now by year three, we've paid 67,688, but only $34,078 has actually gone to the principal. So the balance is still quite high after three years of working hard and being on that treadmill. And after five years, we've made all those payments now we've slowly tip the scales a little bit extra. Is going to the principal still very close. We have a balance of 3,340 1,489. We've paid 112, almost 113,000. And just shy of $59,000 has is the amount that went to principal. So not only is the bank getting use and control over 100% of this payment here, but more than half of it has flowed, or almost half of it is flowed just directly to interest. Now, here's the problem. One of the problems, if you continued on, yeah, you'd keep on beating it down and after 25 years you would pay this off and away you go. But what does the average Canadian do somewhere between year one and year five in their mortgage term? Well, they sell their house or they buy a new house and they refinance. And they're not actually realizing. They think they're making progress when they refinance. Hey, come in and we've got a new mortgage rate. You know, you're paying 2.92. Let's get you down to 1.99. And because they're focused on the interest rate, it's going to affect your payment. You're only going to pay $1,600 a month. Now, isn't that good, Mr. Client? The client goes, oh, this is wonderful. I'm even going to wrap up some of my debt. I got some credit cards and a line of credit in a car and expand the mortgage a bit, but somehow my payment went down. Isn't that amazing? This is so great. But they don't realize that they went all the way back in time. The payment is a little bit less, but now they're even making, making even less headway because they're right back into that extremely high interest volume, that front end interest payment, right? So then they keep going through the process and then we wonder why we get on calls with people who are in their late 50s, 60s, and sometimes even, you know, their 70s, and they're still carrying a significant mortgage balance because they thought they were doing all the right things their entire life. So if we keep going and let's assume that we kept the same interest rate and we kept making that same payment and we kept just doing the automatic renewals and all that kind of stuff, finally after 25 years, the principal, most of the payments go into principal, a little bits go into interest. And what was the original principal of the mortgage, what we bought the house for was.

$400,000. And we ended up actually paying 564,068 in total. And we paid a total 164,073 in interest. Now, I'm no math whiz, but if I look at this math quickly, if I divide 400,000 into 164, I'm landing somewhere in the 33ish percent range. I'm guessing, even if it's just 30 or somewhere between 30 and 40, that's the difference between interest rate and interest volume. The interest rate is just a number. It's just a number that's, you know, the big flashing sign outside the bank to get your attention. Interest rates are what are used to attract money by banks or investment opportunities. Average rate of return is 8%. Well, that might attract money because 8%. I want 8%. Or.

In this case, like I'm just using an example. Hey, come refinance. 1.99%. Well, that attracts money. People think that, that it's a great opportunity for them, but they don't realize because of how the loan is structured. 1.99 is nowhere. Do you see? We don't see 2.92% anywhere on this page or this slide. That is what's happening today. This is the real truth in lending. And we're starting to uncover the problem.