SLADE COLUMN: Whats the payment? may be the wrong question.
‘What’s the payment?”
The first time I ever heard that question was in South Carolina, as I was telling a friend about a car I had purchased.
I thought it was an odd question, although I have heard it many times since then. It’s an odd question because the monthly payment tells you little about the cost.
A monthly payment on a loan might be low because of a lengthy loan term, or a low interest rate, or because there was a large down payment. A monthly payment might be high because a larger amount of a purchase was financed, or the loan term is shorter, or the interest rate is high.
The important question is: What will the car, or the house, or the new roof or whatever actually cost when you add up the payments?
A five-year car loan with a 3 percent interest rate would have lower monthly payments than a four-year loan with no interest, for example, but would cost the buyer more overall.
When people buy something expensive and durable, they often finance the purchase with a loan, and of course they would want to make sure the payments are affordable.
But affordable payments sometimes can mask the true cost or, worse yet, obscure unreasonable interest charges.
The challenge for savvy consumers is to sort through all the ways that sellers might attempt to make purchases seem less expensive.
Take, for example, an actual mortgage loan I reviewed last month with a Charleston-area couple who were struggling with their payments and trying to refinance.
This couple had borrowed just under $145,000 for the primary mortgage on their new home, back during the housing bubble. Seems they did not really understand the terms, and had been steered into what’s now known as a “toxic mortgage” by a broker working on commission.
So, what was the payment?
Well, the payment was initially $1,172 a month, rising to $1,612 after two years because the loan rate adjusted twice before becoming a fixed-rate loan.
But that’s not the point. This was a 40-year loan with 30 years of monthly payments and a balloon payment at the end, with an interest rate roughly double the going rate for people with good credit — nearly 13 percent in annual terms.
Here’s what that means: Forget about the payment. During the first five years of the loan this couple could have made every payment on time, and they would have paid off just over $1,000 of the balance, with more than $84,000 being paid in interest.
The monthly payment masked the high interest rate, and the fact that the loan was structured so that they had little hope of gaining home equity.
If they made all of the payments for 30 years, there would be a balloon payment of about $105,000 waiting for them at the end. All but about $40,000 of their payments for three decades would have been for interest.
So, it mattered not at all what the monthly payment was. What mattered was, they got into a truly horrible loan product by focusing on the monthly cost and taking the advice of people who stood to profit from the deal.
I expect to be writing more about their situation, which is a cautionary tale for anyone financing a home, or even a vehicle. Always make sure you know the true cost of financing, particularly the annual percentage rate of any interest charges, and the total value of all payments.
Otherwise, you can get into a situation that many people face with credit cards; making low monthly payments but paying high rates of interest over long periods of time.
With all of the loan refinancing going on right now, due to record-low interest rates on car and home loans, it’s also important to understand how loan terms and interest rates work together.
Just last weekend, I was talking with a relative about one of her friends who has refinanced a mortgage multiple times at progressively lower interest rates.
The problem was, while this serial refinancer was focused on how the payments kept dropping each time the mortgage was reworked, she was refinancing into new 30-year loans each time. That meant the borrower was extending the term of the loan, which raises total interest payments, at the same time the interest rate on the loan was being lowered.
The cost of any long-term loan is a combination of both the term — the longer the term, the more interest you pay — and the interest rate.
Reach David Slade at 937-5552 or Twitter @DSladeNews.