What exactly happens to my mortgage debt when I sell my mortgaged home?

Question

Let's say I am buying a house for 100k. I put 10% down (10k) and my bank gives me a loan of 90k. However I also become liable for paying interest on that 90k, e.g. with total of 30k that I need to pay off in 20 years. This makes my overall debt be 120k. Let’s say after I bought the house for 100k, a couple of years later I found a buyer ready to buy that house from me for 110k.

So if I sell the house for 110k presumably making 10k extra, but will I:

• still have to repay the bank 120k even though just 2 years have passed and I become a sad 10k debt owner?
• or does my obligation stop once I do not own the house any more and I become a happy businessman with extra 10k?

My gut tells me that I will still need to pay the extra 10k to my bank, but my mind is not accepting it as a transaction because there is no real estate any more in my possession, and also my new buyers potentially got their own mortgage from the bank, would not it mean double debt for the same property?

Answer 1

You're misunderstanding the interest portion. You don't immediately "become liable for" and owe all of the interest on the loan up front. Any "total interest" calculation presented at the beginning of the loan would be based on the assumption that you follow a particular payment scheme (laid out in the mortgage contract), incurring interest each month until the loan is paid off.

In the scenario you described, you borrowed 90k from the bank. You therefore owe the bank 90k. Every month that you don't pay back the full outstanding balance of your loan, you owe interest on the balance. Your monthly payment is calculated such that you will pay this interest and also pay a bit of the loan balance, thereby decreasing what you owe and decreasing the interest that will accrue the next month. Once you've paid off the loan, you don't owe any money, so no additional interest accrues.

If at some point during the loan you sell the house for 110k, you will have to pay the bank the balance of the loan and any interest that has accrued since your last payment.

Answer 2

From the bank's perspective, the mortgage (of whatever term, say 30 years) is an interest-bearing asset, somewhat like a bond or certificate of deposit. It is understandable why you are concerned about whether you continue to owe interest after selling the house. After all, someone who owns a bond or CD with a specific term does not normally expect their interest income to stop early, at some date outside their control, at the discretion of the party they lent money to. What is different about the mortgage?

1. The mortgage is callable, usually with no prepayment penalty. At any moment, there is a "balance" or "payoff amount" that represents what you can pay right now if you want to end the mortgage forever and have no debt on your house. This amount is a function of not only the cash that has changed hands so far (your payments to date) but also the time that has elapsed. Just like a bank account in which deposits and withdrawals can be made, the mortgage balance grows a little each day based on an interest rate as well as shrinking upon each payment. For example, if your balance today is $90,000, your balance tomorrow might be $90,010, except if you make say a $1,000 payment (which is like giving the lender a "withdrawal"), then it would be $89,010.

2. The mortgage is amortizing. There is a planned schedule of payments, which will result in reducing the balance to zero at the end of the mortgage term. The initial balance, term, interest rate, and scheduled payments are not independent numbers but satisfy the consistency condition that the balance, updated each day according to the process above, will reach zero on the prescribed date (typically, the balance will decline slowly at first, then quickly). But being callable means that the scheduled payments are a minimum requirement. You, the borrower, can pay more and/or earlier at your discretion. Doing so will reduce your total interest cost and thus the total amount you pay on the mortgage.

3. The mortgage is secured. This means that if you fall behind on payments, the bank can seize and sell your house to cover the debt. It also means that if you sell the house, you must pay off the mortgage in full (meaning its balance on that date). Normally this is automatically paid with part of the money you get by selling, and you keep the remainder (your equity in the house).

The key variable not addressed in your question is: What is your mortgage balance on the day you sell the house for $110,000? If you have a "normal" mortgage (as opposed to interest-only or negative-amortization), this balance will be less than the original $90,000 you borrowed. Thus, you will walk away with at least $20,000 (ignoring commissions and closing costs). Of course, to evaluate profit, you'd have to net this against your down payment and your total interest paid to date. "Interest paid" here equals the amount by which your total payments exceed the reduction in the mortgage balance.

Answer 3

This makes my overall debt be 120k.

This is not exactly true - you are only responsible for interest accrued while you have a balance with the bank. If you sell the house, you will need to pay off the mortgage, which means that you no longer owe them any interest. As you make payments, some of that money goes to pay down the principal that's owed, and some goes to pay the interest that has accrued for that period.

When you are getting ready to sell your house, the bank will give you a "payoff balance" which is the remaining principal plus any interest that has accrued since the past payment. After you pay that, you don't owe any more.

In your scenario, you would have made a 10k "gain" by selling your house for more than you paid for it.

Answer 4

The other answers have covered the majority of the confusion - "interest accrues over time, not up-front or at the end.

But there's another consideration here: You also need to check the Ts&Cs of the mortgage, to check for "Early Payment Charges" ("EPCs").

Many mortgages charge you a fee for repaying the mortgage early. Often "early" is also the "fixed rate" period of the mortgage. e.g. a "4 year fixed rate" mortgage will also have EPCs for those first 4 years.

Roughly speaking, those fees are to counter the money that the mortgage company is "losing" by giving you a better interest rate. They gave you that rate on the assumption you'd provide a reliable income for a while. If you're leaving early then you've had the benefit of the low rate, and they aren't getting the long-term income.

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You also need to think about all the general costs associated with buying and selling a property. Ignoring the mortgage interest for a moment, if you were to buy in cash at 100k, and then immediate sell at 100k, you'd find yourself down by a decent chunk, for legal fees, surveys, Taxes, etc. etc.

Answer 5

Check your promissory note to see what you’re agreeing to if you sell. Most notes in the US will have a “due on sale clause”, e.g.:

“If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument.”

The “all sums secured” means the balance of your loan net your escrow balance and some small amount of interest due, which is in total going to come out to approximately whatever unpaid balance remains. The servicer can tell you the exact number.

So if your unpaid balance was about $90K, you would owe about $90K upon selling the collateral.

Other stuff about interest and how long you’ve had the loan and whatnot has no bearing as “prepayment penalties” are unlikely to apply in 2020. You simply pay up what is owed.

Answer 6

There are lots of good answers above.

Three basic ideas that apply to your question assuming that you are in the US and are purchasing a home for your personal residence.

First, when you are told how much you will pay, that is an estimate that assumes many things, among them that you make every payment as small as legally permitted but make each on time. It is close to being a worst-case estimate. And it greatly exceeds your legal debt under the mortgage because the debt legally due is basically just unpaid principal and unpaid but accrued interest. (I say "basically" because there may be amounts due for things like property taxes paid by the lender, but future interest is not yet a debt.)

Second, things get more complex and expensive if you fail to pay amounts when they are due. Then what is legally due may escalate beyond that original estimate.

Third, if you sell the home, you will almost certainly not have to work all these details out yourself. Your lender will not "release the mortgage" (meaning in practical terms that the sale will seldom even happen) until your lender has been paid in full what is due on the day of sale. The mechanics of this frequently involve the buyer's lender paying the amount due under the mortgage to your lender: you and the buyer are only nominally involved. But all interest theoretically due from you after the day of sale disappears forever.

Answer 7

It should go without saying, but this depends on the terms of the mortgage contract you signed. Whoever fronted the money was making an investment with an expected, long-term return of a fixed (or variable) interest rate. If you pay off your debt (the principal) early, they got their investment back but not the expected return. Some contracts anticipate this loss and impose a prepayment penalty. Buyer beware!

Answer 8

However I also become liable for paying interest on that 90k, e.g. with total of 30k that I need to pay off in 20 years.

That's only true if you take the whole 20 years to pay it off.

What's really happening is every month (or, more often) they are calculating how much money you actually owe them in that instant, and charging you interest for the use of that money.

Your credit card does exactly the same thing, you know.

People don't like uncertainty, and so they projected that if you make only the minimum payment on the mortgage every month for the full term, then interest will amount to that much -- in fact, this projection must be done to correctly compute the monthly minimum payment. The assumption is that you want all payments to be equal, and have the last payment finish with a balance of $0.00. That's actually a pretty tricky math problem.

It is a plan. You don't have to follow it. You can exceed minimum payments.

This makes my overall debt be 120k

No. That's only true if the mortgage runs to term and you only make minimum payments.

Your credit card has a very similar statement as well. However, with the credit card you don't plan to pay minimum payments forever, now do you? Obviously, if you make more than minimum payments and pay the card off, then that projected interest never happens. So you disregard that number.

Well... same here.

Selling the house instantly pays off the mortgage, which means they stop charging interest. So the 18 years of interest payments never happen.

What really happens.

I fired up a random amortization calc and tweaked it until I matched your facts: $90k/20 years/$30k interest. According it you've been hacking down the principal of the loan about $280 a month. After 2 years the loan principal is down to $83,000.

So. You sell for $110,000. The buyer writes a $110,000 check and gives it to the escrow company. The escrow company gives an $83,000 check to the mortgage. You are out of the mortgage free and clear. They also make out a $27,000 check to you, because that is the rest of the money.

Oh, wait. In reality, the escrow company also takes care of a bunch of items that the seller is responsible for paying. That includes closing costs, Realtor commission, title insurance, blah, blah, etc. There's a zillion of em. So your check will be somewhat less than $27,000, but certainly fine money. You then flip that as the down payment on your next home. (or to pay off the bridge loan you used to get the down payment you already made).

You really don't know much about money, though. Learn more.

The nature of this questions has exposed your inexperience with personal finance. A lot of people have "money skills" programmed into them by family, too, and that leads people to "know" stuff about money that just ain't so.

But in reality, knowledge is power. Knowledge is freedom. I am modestly skilled at money, and that means I work when I want to. I am sitting out the lockdown doing exactly what I want to do. Money doesn't worry me or scare me.

Choose to make it a thing to raise your skills and understanding of money. Start reading/following Suze Orman or Dave Ramsey. Read John Bogle's book "Common sense on mutual funds". Let go of what you know that just ain't so. Make yourself an expert. You'll have a lot more control over your life!

Answer 9

Putting it very simple in 2 sentences that may help with capturing the big picture: at the moment the new buyer pays the debt, all the addition in the original price no longer exists because this addition was related to future interest and risks. So the $10k you expect to have on your hands doesn’t really exist anymore.