Half-Life
Categories: Metrics, Accounting
Anyone whose brain immediately went to thoughts of carbon dating and cool dinosaur fossils when they saw the term “half-life,” we want to go ahead and stop you right there. Not what we’re talking about today.
In the financial world, the term “half-life” is less The Land Before Time and more the land, uh...getting paid off. That’s because a half-life is the expected date on which half of the principal of a mortgage loan will be paid off, which, like carbon dating, ends up being more of a time estimate than an individual, specific date.
Why? Stuff happens. Maybe we make some late payments, or maybe the terms of our loan change. Maybe we find some old Spanish doubloons in our basement and use them to pay off a huge chunk of the mortgage all at once. Whatever we’ve got going on, when half the principal of our mortgage is paid off, that's its half-life.
Half-lives are also used in the world of MBSs, or mortgage-backed securities. The concept works the same way: when half of the principal attached to that security is paid off, that's the MBS’s half-life. We can make estimates about when that happy day will occur, but just as with individual mortgages, our best guess is still...a guess. And, just as with individual mortgages, lower interest rates typically means they’ll get paid off faster, while higher interest rates means they’ll get paid off more slowly.
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Finance: What is a mortgage's amortizati...3 Views
Finance allah shmoop what is a mortgage amortization schedule and
how does it work All right we'll think of mortgages
Is the jet i warrior of bonds Their special government
kissed even there not just a typical bond like a
car loan or alone for that new turbocharged skateboard you
had your eye on Mortgages carry one key special feature
that's an integral part of what has made america great
The interest payments on bonds for mortgages are tax deductible
So if you're paying fifteen hundred bucks a month and
mortgage payments and the highest or a marginal tax rate
that you pays forty percent with federal and state taxes
combined and most of that fifteen hundred boxes interest which
is the case in the early years of pain off
these things than the fifteen hundred dollars payment feels like
only about nine hundred bucks on an after tax basis
like forty percent of fifteen hundred and six hundred dollars
You subtracted from the fifteen hundred there And you get
sweet luscious deduction meaning that it's say well ninety five
percent plus of that fifteen hundred dollars for interest than
in that year You'd have twelve payments of fifteen hundred
dollars or total payments made to the bank of eighteen
grand That's round a bit here and say that seventeen
grand of it was interest i you paid down a
thousand bucks of principle And if you earned ninety thousand
bucks that year with the tax rate of say thirty
percent federal in ten percent state on earnings from seventy
thousand to one hundred grand well then on the amount
over seventy grand iaea get to that ninety grand of
your full year earnings Well you would take off or
deduct seventeen thousand dollars from the ninety and pay taxes
on earnings of just seventy three thousand box The government
lets you deduct the interest payments against your taxable earnings
as if in fact you had never had those taxable
earnings in the first place They essentially give you a
discount on the net after taxes interest rate your paying
in the form of a give back on your taxes
So let's dive into a mortgage amortization schedule and amortization
here just refers to the pace at which you reduce
the principle you owe over time and we have this
pretty chart to help illustrate that So you finally bought
that four hundred fifty thousand dollar home It's an almost
literal shoebox in palo alto but well its home or
it will be You went to the bank and got
alone for three hundred fifty thousand dollars After putting one
hundred grand down your loan is a thirty year loan
They offer them and all kinds of flavors like fifteen
year loans interest only loans or reverse mortgages A whole
different kettle of fish there Well in this case note
the monthly payments Each payment is the same two thousand
forty two dollars fifty cents a month and note that
the first payment is three hundred sixty five bucks in
change in principle paydown See right there and sixteen seventy
seven and change in interest So after that first month
the principal owed is three hundred fifty thousand minus the
three hundred sixty five dollars in principle you paid down
or three hundred forty nine thousand six hundred thirty five
dollars ish So if you go on about your business
for fifteen years well the ratio of principle to interest
looks dramatically different at this point Well again on the
same payment of two Oh for two point five o
the principal covered by that payment is eight hundred sixty
box and the interest on the loan is now down
to about eleven eighty three And note that after fifteen
years thie amount owed on the home is down from
three hundred fifty thousand Right That's the loan you originally
took out Two Now a principal set of about two
hundred forty six thousand like you've paid down over one
hundred grand So you're still making the same monthly payment
of two oh four to fifty But on lee eleven
eighty three of it the interest portion is deductible So
from an after tax perspective that mortgage gets a bit
more expensive each year as the principal has paid down
in a higher portion of the mortgage payment then comprises
principal pay down which is not deductible versus interest payments
Which are so then what do things look like near
the end Different We're talking about the end of the
mortgage period Yeah well that last payment is again in
two o four to fifty but it comprises two o
three Two of principle pay down and yes about in
box of interest That's it So then after thirty years
you'll have paid a total interest amount of over three
hundred eighty five grand That's just an interest So think
about that number It's more than the entire amount of
the loan you originally took out So you have wow
two oh four to fifty a month Tone your dream
home That's it right No not at all Remember you
have insurance and depending on what kind you get and
i'll figure around three hundred bucks a month toe over
a grand And then you have real estate taxes and
figure about one and a half percent of the purchase
price which then goes up about the rate of inflation
overtime So on this four hundred fifty thousand dollar home
that's real estate taxes of about sixty sir seven fifty
ish year about five fifty a month And for many
first time home buyers you have to get pm i
or private mortgage insurance That's kind of safety cushion for
the bank not for you and is laid on is
an additional expense When the homeowner has put on ly
a small amount down as a down payment that is
the homeowner has to pay some percentage of alone They've
taken out In addition to that base interest of say
six deductible percent like you have to pay an extra
one non deductible percent in pm i until they can
get the bank to agree that their loan to value
ratio is less than eighty percent That's kind of like
the bank's magic number or set another way that the
equity they have in the home is mohr than twenty
percent of its value Or so why like why would
the bank do this other than to make it yet
more profit from you mr or mrs vulnerable mortgage taker
But the reality is that if the bank ever does
have to foreclose on the house and then sell it
and spend a fortune on legal bills evicting you let
alone dealing with all the bad press it gets extremists
all excited about regulating the bank's further you know because
of course it was the bank's fault that you were
drunk and got fired from your job and spent your
dough on fast cars and even faster robots So banks
make risky small down payment makers take out cushion insurance
in case well this ever happened so that they aren't
the ones left owning a house they never signed up
to buy Yeah Hey at least there's a white picket 00:06:00.835 --> [endTime] fence Go for it No