The Principle & Interest Portion Of Your Monthly Mortgage Payment
Many people get confused about their monthly mortgage payments and how they are calculated?
It helps to understand that a loan is “amortized,” which means you will be paying it off over time, usually with monthly payments. The payments you make are set up to pay both interest and principal. When you have a fixed-rate mortgage, your payments stay the same over the life of the loan.
The meaning of “amortize” and “mortgage” both come from the Latin word “mort,” which means death. When you amortize your loan, you are basically killing off the debt. This is different from a loan that goes on indefinitely. A mortgage has a set term, and a length of time you are given to pay the loan off completely.
The formula for calculating the payment is not simple. The easiest way to estimate your payments is to use a mortgage calculator when you can enter several variables.
Understanding the interest calculation of your loan... Let’s look at an example loan amount yo explain this portion.
For a loan of $100,000, with a fixed interest rate of 4% for a period of 30 years, your monthly payment will be about $477. Most of this will go toward the interest in the early part of the loan. So, for example in your first $477 payment, $333 of the total would go towards interest and the remaining $144 will pay down the loan's balance.
This will make more sense if we look more at this example. With a $100,000 loan amount and a 4%, your interest rate that equals $4000/year in interest. $4000 / 12 months = $333 which was the interest for the first month. After your 1st payment the balance of your loan has been decreased by $144 which leaves a new balance of $99,856. Because the remaining balance is lower the amount of interest is also less and the balance of your payment that goes to pay off your loan is correspondingly greater. In fact, at the end of the first year you will owe $98,239 which means you would have only paid off $ 1,761 of the principal of your loan.
For many buyers, they are shocked to realize that they have paid almost 6,000 in mortgage payments yet paid off less than $2000 of their loan's balance. However, it does make sense because the lender needs to continue to get the interest on the loan's balance owed while also helping you to pay down the loan, in this example, over 30 years. With each year of payments, since your payment amount stays fixed, more and more of the payment will go to paying off the loan principal and less will be used to cover the interest. Again, this happens because with each passing payment, there is a little less remaining on the loan so there is less interest to pay. Again, since the interest payment decreases over time, and your payment amount remains constant, that means that with each subsequent payment you are paying off more of the principal then you did the prior month. After around 13 years of making payments this split between principal and interest will be almost equal, with about $235 going to interest and 242 going towards paying off the loan. Each year after that, a greater portion of your payment will go towards paying principal vs. interest.
If you have an interest only loan, then while your payment would stay at only $333, because the loan balance itself would never be decreased. Most lenders though will not allow this to continue for too many years. Usually, the lender will limit interest only payments to only five to 10 years. Then, once that 5 -10 years ends, typically your payments will increase so that you can pay off your loan over the next 30 years.
When you refinance a loan, you start over. Your 30-year term begins again, and you start again at year one, paying mostly interest with each payment.
With both a new mortgage and a refinance, typically your first mortgage payment will be due on the 1st day of the month, that immediately follows the month AFTER you closed. This happens because the interest is paid in arrears (after the fact) and it must accrue. So, if you close on the 25th of April, typically your first payment would be June 1st which is the first of the month that follows the first compete month of May. In this example, at closing on the 25th, you will typically pay as part of your closing costs, the daily or prorated interest for the last 5 days of April which in this example would be April 25th to the 30th. You are prepaying this interest at closing since these days are not be covered by your first payment on June 1st that only pays the accrued interest only for the month of May.