A
mortgage is a long-term loan that a borrower obtains
from a bank, thrift, independent mortgage broker, online
lender or even the property seller.
The house and the land it sits on serve as collateral
for the loan. The borrower signs documents at closing
time giving the lender a lien against the property.
If that borrower doesn't make payments as agreed, the
lender can take the home through foreclosure.
Because mortgages are such large loans, consumers pay
them off over long periods -- usually 15 to 30 years.
Their monthly payments gradually whittle away the principal
balance, slowly at first then rapidly toward the end
of the loan.
What's in a payment?
When escrow is used, a monthly mortgage payment is called
a PITI payment. That's because each one covers a portion
of the following four costs:
- Principal -- the loan balance
- Interest -- interest owed on that
balance
- Real estate Taxes -- taxes assessed
by different government agencies to pay for school
construction, fire department service, etc.
- Property Insurance -- insurance
coverage against theft, fire, hurricanes and other
disasters
Borrowers can choose to pay their real estate taxes
and insurance in lump sums when they come due, rather
than in monthly installments to their escrow accounts.
Depending on the kind of mortgage a borrower has, the
monthly payment may also include a separate levy for
private mortgage insurance (PMI) or government-backed
mortgage insurance premiums.
The breakdown of each payment (the amount that goes
toward principal, interest, etc.) changes over time
because mortgages are based on a repayment formula called
amortization. That's a fancy term meaning the lender
spreads the interest you owe on the mortgage over hundreds
of payments so that the overall loan is as affordable
as possible.
How does amortization work?
|
| Payment number |
Principal balance |
Payment amount |
Interest paid |
Principal applied |
New balance |
| 1
|
$150,000
|
$1,048.82
|
$937.50
|
$111.32
|
$149,888.68
|
| 60
|
$142,086.93
|
$1,048.82
|
$888.04
|
$160.78
|
$141,926.15
|
| 120
|
$130,426.14
|
$1,048.82
|
$815.16
|
$233.66
|
$130,192.48
|
| 240
|
$88,851.22
|
$1,048.82
|
$555.32
|
$493.50
|
$88,357.72
|
| 359
|
$2,078.14
|
$1,048.82
|
$12.99
|
$1,035.83
|
$1,042.3
|
| |
On a 30-year, $150,000 mortgage with a fixed interest
rate of 7.5 percent, a homeowner who keeps the loan
for the full term will pay $227,575.83 in interest.
The lender can't possibly expect that person to pay
all that interest in just a couple of years so the interest
is spread over the full 30-year term. That keeps the
monthly payment at $1,048.82.
But the only way to keep the payments stable is to
have the majority of each month's payment go toward
interest during the early years of the loan.
Of the first month's payment, for instance, only $111.32
goes toward principal. The other $937.50 goes toward
interest. That ratio gradually improves over time, and
by the second-to-last payment, when we're all driving
hovercars and have colonized the moon, $1,035.83 of
the borrower's payment will apply to principal while
just $12.99 will go toward interest. |
