Financial Terms Using Consumer Mathematics

Financial Terms

Using Consumer Mathematics in Everyday Life recent consideration of the idea of purchasing a double-wide/modular home brought about a greater knowledge of what the terms Percent, Simple Interest, Compound Interest, Installment Buying and the Cost of Home Ownership meant. We thought that owning our own home would give us tax breaks and other benefits that renting does not.

First of all, percent to us meant what kind of interest we would be charged in order to take out a mortgage loan. We were advised that, even though we qualify for a mortgage, if we could not afford to make at least a 10% down payment on a home, then we needed to start saving for that. If we couldn't make a down payment, that would mean we would have higher monthly costs. After that, percent meant to me that if we could not afford the monthly costs, then we would join the 100% of other homeowners now in foreclosure who once qualified for a mortgage. (Orman)

The interest rate charged for obtaining a mortgage loan was of special interest. We wanted to get as low a rate as possible, to keep the bottom line for purchasing the home and property to the minimum. Six percent was what we wanted. If we put $20,000 down and the mortgage was for $180,000, on a 30-year, fixed rate mortgage, a six percent loan would come to $1,079 per month. This was assuming that we would qualify for a six percent mortgage loan. Upon checking out our credit scores, we found that we would have to pay closer to 7.8%, since we weren't in the top group of people who qualified for these low-interest loans.

In order to understand our credit scores we needed to find out these scores were decided. We looked at our bookkeeping and at the interests we were paying on other loans and credit cards. We were amazed at how much interest we paid per year, versus how much we were actually spending. Simple interest is all the interest we paid during the last year. We divided that by the principal at the beginning of the period (say $100 principal). A credit card charging us $1 a month equaled 1/100 or 1% a month (this does not mean it is 30% a month GIC). But a $100 certificate of deposit where $6 was paid to us at the end of the year was paying us 6/100 or 6% a year. We asked what about the interest that is due to us during the year on our CD, but not paid. Did it remain "interest payable" after six months, or is the $6 added to the principal monthly, like on the credit card? They explained, each time it is added to the principal, it 'compounds,' so the interest from that time (at the end of the year, in this case) the interest is calculated on that larger principal ($106). The more frequent the compounding, the faster it grows. Since the interest was only compounded yearly, this CD did not grow very fast.

Compound interest is the interest added to the principal which results in a "new" principal amount by which interest is calculated. Interest is calculated only for a certain period of time. The shorter the period of time, the faster the compound interest accumulates, because it is calculated on principal plus interest each time it is calculated. A daily compound interest of $6 would accumulate 365 times that calculated for a yearly compound interest.

Our mortgage, should we choose to obtain one, would be payable and compounded monthly. The amount of interest that we would pay each month is the rate (say 6%) divided by twelve (multiplied by the principal). Therefore, the yearly compounded rate is higher, actually, than the disclosed rate. In Canada, mortgages use semi-annual compounded rates, while payments are still monthly. Mortgages in the U.S., however, are mostly payable and compounding monthly, which means that U.S. homeowners are paying more in interest on their homes than Canadians, as the yearly compounded rate is higher than the disclosed rate.

Buying a home, we found, is a lot like buying smaller things, as we have been doing, on credit, with credit cards, which is called "installment buying." Installment buying stipulates that, although one may "purchase" something with a credit card and use it, it legally still belongs to the seller until the last payment is made. If the buyer defaults, the goods revert to the seller and the buyer forfeits all past payments. Layaways are also a form of installment buying, in that payment "installments" are made monthly or weekly, however often the purchaser wishes to make payments, but the merchandise is held by the retailer until the item has been paid for completely. (Infoplease)

If one buys on the installment plan, one pays interest on unpaid balances, and therefore pays a higher price for goods than those who buy outright. The Board of Governors of the Federal Reserve System supply statistics show the amounts of credit extended and outstanding to finance automobiles, mobile homes, and other consumer goods.

We were investigating purchasing a home, but found that the cost of home ownership is higher than we thought. In order to own, and not rent, one must pay not only for the mortgage (which monthly payments may be higher or lower than the rent we now pay), but probably another 40-50% more. There are property taxes on the value of the house and property, which would come to thousands of dollars per year. There is the need to have homeowner's insurance (required by mortgage lenders), which might run $25 per $1,000,000 per month. If a down payment is not paid, or is borrowed from another source, an additional Private Mortgage Insurance will run about $45 per $100,000, which would be about $90 a month. In addition to these mortgage-related costs, there is the simple fact that home maintenance is up to the homeowner. If the plumbing bursts or the roof leaks, that is a major expense that must be paid for by the home-owner, and these things happen periodically.