(Article by James Montgomery from the San Antonio Business Journal, 18 January 2008)

We all go to school for about 13 years, kindergarten through high school. Some of us go to college and then graduate school. Personally, I went to school for three years beyond college with law school and took financial courses after that was over. In all of that time, with economics courses, accounting courses and even tax courses, no course or school ever covered what we are going to talk about below.

It was not until I became president of a financial institution in my early 30s that I was exposed to the effect of loan payments, actually by accident. The institution was not making money, but losing money. We did an analysis of the income and quickly realized that because our loans were older -- loans had been made more than 12 years before -- the institution was not earning much interest from those loans. Interest is an important way banks make their income. Let's look at part of the analysis.

You want to buy a house for a contract price of $180,000. With a down payment of $30,000, you need a loan of $150,000. Your lender can provide a loan at 7 percent fixed interest for 30 years.

So are you paying $180,000 for the house? If you pay cash, yes. The real price with the $150,000 loan is $30,000 plus the payments on the loan for 30 years. Monthly for 360 months (12 months times 30 years), you will pay $997.95 or total payments of $359,362. With your downpayment, you are actually going to pay $389,262.00 for the house, not the contract price of $180,000.

With 12 months of payments of $997.95 totaling $11,975.40, only $1,523.67 has been paid back on the loan. (See one-year amortization schedule below.) The rest was all interest of $10,451.73. Indeed, 88 percent of your payments went to interest. After seven years, you will have paid $83,827.80 in payments and 84 percent ($70,549.30) was interest. So the older your loan, the more you pay in principal and the less you pay in interest.

One year amortization of a $150,000 loan at 7 percent

About seven years after you buy your house (if not sooner), you will receive a letter from the lender asking you if you would like to refinance. Should you refinance? What is the term of the mortgage being offered? Why 30 years, of course. Here are some tips on how to handle the refinancing. Keep in mind that this advice applies to any type of loan -- not just a home loan.

First tip. If you refinance, don't go longer than your initial term. If your original term was 30 years and you have 23 years to go, then just refinance for 23 years, not any longer. Think about it, if you take the 30 years, you get to pay that big chunk of interest all over again. Don't be surprised if you are not asked to refinance again in seven years, too. You will never build up any equity in the house.

Second, make sure you are getting a lower interest rate. If you cannot improve your interest rate by almost 2 percent, you will probably not save any money by refinancing after costs to refinance.

Third, if you sell and move to a new house every five years or so, realize that you are missing one of the big benefits of home ownership: equity build-up in paying down your loan. So what do you do? When you get a new loan on your new house, just get a 20-year loan or the remaining life of your loan on your old house.

Fourth tip, if you did not have a house payment because you had paid off your loan, how much monthly income would you need to pay your monthly bills? One way to achieve financial freedom, meaning you don't have to work just so you can pay your bills, is to pay off your home loan and other debts. By the time you want to retire or have financial freedom, have the goal of no house payment other than taxes and insurance.

James Montgomery is a San Antonio attorney who advises businesses on exit strategies, buying and selling businesses, forming and restructuring businesses and planning corporate strategies.He can be reached at 210-690-3700 or at jemlaw@mac.com.