I’ve got some good news. When you think in inflation-adjusted terms, you’re really paying more mortgage principal with each payment than you may think. The bad news is that home buyers these days have a punishing amount of principal to pay.
When it comes to money, it’s important to think in inflation-adjusted terms. It’s easy to get lulled into the feeling that a dollar today is the same as a dollar was last year. But it isn’t the same. Dollars are leaky; it takes more of them to buy the necessities of life each year. The leak is slow enough that we don’t feel it every day.
Fortunately, the leakiness of dollars works to a borrower’s advantage. Suppose that you’ve just taken on a $250,000 mortgage at 3% interest. Amortized over 25 years, the monthly payment is $1183. After the first payment, the balance owing drops by $562.
When we think in nominal terms (as though dollars are constant), we would say that your first payment was split so that you paid $621 in interest and $562 of the principal. This is the way the Canada Revenue Agency sees it.
However, using the average inflation rate in Canada over the last 5 years of 1.73%, the inflation-adjusted mortgage principal actually dropped by $920 over the first month. This means your real interest payment was only $263; the remaining $920 of the mortgage payment was applied to the real principal.
So, we see that even from the very first mortgage payment, you’re primarily digging into real principal. I would never say that your mortgage interest rate doesn’t matter, but it’s clear that it’s not the only consideration. The size of the mortgage is the big concern these days.