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### Course: Finance and capital markets>Unit 2

Lesson 3: Mortgages

# Introduction to mortgage loans

Learn how mortgages work, how to use a mortgage calculator, and how to use a spreadsheet to show the payoff of a mortgage over time and the interest paid each year. Click here to download the spreadsheet from the video. Created by Sal Khan.

## Want to join the conversation?

• Can you make a video on student loans please and explain if the bank actually makes money off of the student loan of not.
thank you
• Let me first say that I am not an expert, and what I say is a reflection of what I have learned here in conjunction with my own experience.

That being said, it is my understanding that the bank makes just as much money (if not more in some cases) on student loans as it does other loans.
Consider the following scenario:
Your student loan is for \$20k, to be paid back over 15 years at a 5% interest rate. Then your payments are roughly \$150 every month.

But many student loans allow you to pay off only the interest each month for the first 2 years or so. Then your payments are roughly \$80 every month for the first 2 years. At the end of those 2 years though, your balance is STILL 20k, and so its essentially like you have paid the bank almost \$2000, and now you only have 13 years left to pay of a 20k loan, which makes your payments for the rest of the 13 years closer to \$170 a month instead of the \$150 before.

Another thing done by some banks, is that you are allowed to not pay anything for two years after you graduate. But this is even worse, because unlike the other 2 scenarios where you pay back a 20k loan, now you have 2 years worth of interest on that loan, which makes it like you have only 13 years to pay back a 22k loan, which makes your payments closer to \$200 a month.
Note that in both special cases, the bank makes more money off of a student loan than a regular loan because the loan doesn't get paid off at all in the beginning, where as most loans have a payment that is some percent principal, and the rest interest.
• To what extent is making extra principal only payments beneficial?
• As a homeowner who recently came up against this exact question, I would strongly caution against Ctrader's response. I am not an expert, but this is how I understand it: The khanacaduser is correct, you pay off the mortgage from the back end, and continue to make the same payments. That DOES NOT mean your return on investment is equal to the interest rate of the house. Why? It is easiest to understand geometrically/visually, looking at the amortization graph in this video. If you were to pay down interest such that you could pay off the house 5yrs early, you would save that small triangle of interest between the 25th and 30th year of the loan. That tiny triangle is nowhere NEAR the return you would get from an alternative investment at a compounded 5% rate. The actual value will be a fraction of a percent, which is a very poor investment. The ONLY way paying down the house early becomes a reasonable investment is if you get the loan recast. A re-cast is a recalculation of the amount of interest that SHOULD be paid. The video is unclear on this point, and makes it seem like the bank will do this automatically, as they should. This is not the case. You have to request a re-cast, and pay the bank to do this, IF it is available for your type of loan at all (it was not available for mine).

When I bought my house, I did not understand the mortgage from an investment perspective. I would really appreciate a video showing the investment perspective of mortgages, particularly the return on investment of paying a house off early, and also the effective interest rate if a house is SOLD early. Imagine you sell a house after 5yrs, and 80% of your payments up to that point had been going to interest, do you think you still paid the signed 5%? Not even close. The average homeowner sells their house after 7-10yrs, so what is the ACTUAL interest rate paid by most homeowners? Pretty astoundingly high. How on earth is it legal to make these contracts without disclosing the consequences? Khan academy, please post a video on this topic.
• How did he determine the interest for the first month? Isn't \$375,000 x 0.46% \$1725?
• 0.46% is a rounded off figure, the exact figure would be .4583333% (5.5 / 12 %) , \$375,000 x 0.45833% = \$1718.75
• Sal, when you said "the title of the house goes to the bank", does that mean that when you want to rent out that house or sell it again, does the money go to the bank because the bank owns the house, or can you make a deal with the bank?
Thanks for the help :D
• What Sal means is that the official ownership documents for the house (the "deeds" or "title deeds") are kept in a safe at the bank. The purpose is to stop you selling the house without the bank knowing about it, and you keeping ALL the money, rather than paying back the bank what you owe them.
If I moved house, I would get money from a bank for the new house that would pay off the money I owe on the old house, so the bank would give the "deeds" (official ownership papers, remember) from my existing house to the new buyer (or their bank, if they, too have used a mortage), and my bank would get the "deeds" for the new house I buy.
If I rent my house out (and, for example just go live at my sister's house), I may need to tell the bank (depends on local laws and your mortgage contract with the bank), but the rental money comes to me, and then I pay the bank the mortage payments. If there is not enough rental money, I need to find some other money to pay the bank the mortgage payments. If there is "spare" rental money, I get to keep it (subject to local laws about taxes etc., of course).
When you finally pay off the mortgage, and don't owe the bank any more money, you get to have the "deeds" (ownership documents) youself, although a lot of folks then keep them in a bank for safekeeping :-)
The thing about the bank holding the ownership documents for the house even if you pay the payments on time is really just to stop you tricking the bank.
• What is the difference between mortgage and collateral ..??
• A mortgage is what you owe. Collateral is an asset that is used to help you secure such a large loan. Usually with a mortgage, the house is held as collateral. Meaning if you fail to pay your mortgage back, the lender will get your house.
• I'm sorry, but can you tell me from where the monthly \$2,129.21 comes ?
• What is a plain vanilla loan?
• It means ordinary so if I said "This computer is plain vanilla" it basicly means this computer is ordinary, or nothing special
• Does anyone know if mortgages work pretty much the same as this in the UK?
• Mortgages are the same in concept anywhere but in practice this is simply not the case. Often there are government rules that apply to mortgages in a country or region. Such government (regulatory) legislation may be intended to provide safeguards for consumers or to impact consumption incentives; such as tax deductions for first-time home buyers or an added tax for out of state purchasers.

The mathematics can be seen as the general case which is then affected by the specific rules of the country/region.