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## Do You Understand Real Estate Loan Formulas?

** What exactly does a real estate loan formula include… **

All loans are based on a mathematical formula that determines how much you are going to pay. There are five important loan variables: term, interest rate, principal, closing price and payment. These are five important terms that you need to know before applying for any loan.

They are all interconnected and changing one of them is likely to change the others, although often not in the way you would predict. There are some rules of thumb about this, but better not to rely too much on them. Before you start thinking about any particular real estate loan you should spend some time learning the variables with a financial calculator.

**Duration:** It is the term used to calculate loan repayments, often the same as maturity, ie. Remaining time of last installment. Keep in mind though, in case the maturity of the loan is much shorter than the loan term (for example: balloon mortgage). The standard term for a real estate mortgage is 30 years, although in the case of an amortized loan you can choose a term of 10 to 40 years. Generally, the longer the term, the lower the monthly payment, although the change is much smaller than you might expect.

**Interest Rate:** A loan is the amount charged by the lender for giving you the loan. This is usually a percentage of the amount you borrow. The rate is charged each payment period, but it is usually quoted on an annual basis. A 6% interest rate is usually multiplied by 12 0.5% (in the case of monthly payments). The lower the interest rate, the less you have to pay. In case of long-term loans, its effect is more.

**Principal:** The term means either (1) the portion of the installment that is used to reduce the balance or (2) the total amount of the financing. In general, the principal must be greater than (1) the interest rate, otherwise you will suffer from negative amortization (your debt will grow even as you pay the installments). The higher the principal (1) the lower the final value.

**Final Price:** This is the total amount you pay for the loan (including all installments and all additional charges). The final value at the end of the mortgage should usually be zero, meaning the loan has been paid off in full. Keep in mind that the lower the final price you want to get, the higher the installments you will have to pay.

**Payment:** Your monthly (rarely quarterly) amount is due. This important variable determines whether you can ultimately afford the loan or not.

A word of warning: While it’s relatively easy to run the formula on a financial calculator, it’s very difficult to do it on paper, even if you’re good at math in college. An online financial calculator is very fast and does not make mistakes.

Remember, when you choose a real estate loan for yourself, you need to know all five variables – only then will you be able to determine what you can really afford. Often it’s actually better to go for a higher monthly payment if it means a lower final price. On the other hand, you want to spread your loan (longer term and higher final price) to get more money in less installments… The number of possibilities is endless, but you know what they really are if you are. Going to benefit from them.

Good luck with your real estate ventures.

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