After getting a mortgage, the next thing on your mind is how do you pay off your loan?
Even if you are not concerned about that at the moment, you would be brought back to the state of affairs when you receive your debit bank statement for your loan repayment.
Your bank is automated to send money every month to your lender for mortgage amortization.
What Is Mortgage Amortization?
It simply means how your mortgage is paid off over time. Of course, your debt would be reduced as you pay off your interest and principal.
Mortgage amortization also illustrates the way your monthly loan payments are distributed every month for the interest and principal payments.
Every month of your loan term, the money that goes to clear real estate debts is portioned to pay for your principal and principal.
Some mortgage payments also include real estate or property taxes and insurance rates.
At the initial part of your loan term, most of your mortgage payment goes to interest, but as you gain more equity on the loan, much of your payments go to pay off your principal.
A larger downpayment equals bigger equity on your home.
Either way, the mortgage payment remains the same throughout the life of the loan, except if you are on an adjustable-rate mortgage.
Nearly every home buyer has a mortgage and as part of financial culture, the interest rates are constantly changing.
Just an aside for first-time homebuyers and any other person who didn’t know this earlier,
The principal is the initial loan amount you borrowed, interest is the rate you pay for taking up the loan, and equity is the payments you have made over time to clear your loan debts.
Having known this, let’s dive right into the mortgage payment structure
What Makes Up Your Mortgage Payments
The amount of loan you borrow and the loan term determine your monthly mortgage.
Long loan terms, for instance, 30-year mortgages are very popular among home buyers.
A mortgage calculator helps you to easily know the size of the loan you should take up for your new home. It is also convenient for comparing mortgage types and lenders.
Mortgage Payment Components
What Is Principal, Interest, Taxes, Insurance(PITI)?
Principal, interest, taxes, insurance (PITI) is a term used to describe the major sum of a mortgage payment.
Just like the acronym implies, it consists of principal, interest, taxes, and insurance premiums.
PITI are four factors used in the calculation of a mortgage payment. Let’s go through them one by one.
The principal is the initial amount that a borrower applied for in a loan application.
With the way mortgage repayments are structured, the principal balance decreases with time as the principal repayments increases.
Lesser principal repayments are made in the first years of the loan while a larger part of it is made later on in the final years.
Taking a mortgage loan worth $100,000 means that the principal is worth $100,000.
Don’t confuse Principal for principle, Principal vs Principle: It’s Mortgage Principal, Not Principle
Interest is the rate the lender gains for giving you a loan. By loaning you money, the lender is taking a risk, so he deserves a reward the least. This he gains from the interest rates.
The interest rate increases the size of a mortgage payment. A typical interest rate is between 3% – 20%. Higher interest rates result in higher mortgage payments.
If the interest rates on a loan are very high, it decreases your chances of getting a loan and the amount you can borrow.
Government agencies assign property taxes to homeowners every year, but the total tax payments can be split and paid during the monthly mortgage payments for the year.
Real estate or property taxes are used in public service to fund operations and sectors like the police, schools, and fire departments.
Lenders hold these tax payments in an impound escrow account till they are due to be paid.
Insurance payments are also held in an escrow account with the property taxes until when due. Two types of insurance can be included in the mortgage payments: property insurance and Premium Mortgage Insurance (PMI)
Property insurance covers the home from theft, fire, and other accidents. The other is, which is mandatory for people who buy a home with a down payment of less than 20% of the cost. This type of insurance protects the lender if the borrower is unable to repay the loan.
PMI is a mandatory portion of mortgage payment assigned to homebuyers who make their home purchase with a downpayment of less than 20% of the total loan cost.
PMI helps to reduce the risk of loan repayment on the side of lenders. It assures lenders that their loan investment would be paid back to them should in case the borrower defaults.
The PMI is dropped once the borrower has gained up to 20% home equity.
Once the mortgage balance is about 78% of its original amount, all mortgage insurance may be canceled.
A typical mortgage is paid when the principal, interest, taxes, and insurance are taken into consideration. If you cannot meet up with the monthly payments of insurance and taxes, you can inform your lender.
Either way, you would still have to pay taxes and insurance in a year.
The Amortization Schedule: How Mortgage Payments Work
The schedule of your mortgage amortization details how each portion of your monthly mortgage payment goes to the PITI components.
It is organized such that the principal mortgage payments for the first years is lesser but increase with time.
This can be very confusing for a newbie in mortgages because your initial interest can be as high as 5× the principal amount you paid for the month.
Trust me it is quite outrageous.
You can fully understand how different loan schedules work if you get to know how your mortgage amortizes.
As a way of convenience, an amortization calculator can help show you how your mortgage is paid off on both a monthly and yearly basis, and how much interest you have to pay during the loan term.
A refinance calculator is the best approach to loan comparison analysis.
Your loan servicer or mortgage lender may provide you with an amortization schedule calculator so that you can see how your mortgage balance is cleared.
If this doesn’t happen, you can check for free loan amortization calculators online to get a hang of how your mortgage is paid off.
Ordinarily, most people prefer shorter loan terms like the 15-year fixed mortgage, but unfortunately, home prices are so high that home buyers (especially first-time homebuyers) opt for 30-year mortgages.
To understand all this jargon, we have prepared a loan amortization schedule for a 30-year mortgage (360 payments) and a loan amount of $100,000 (variable).
Interest Rate Missing
Observe from the real amortization schedule above, how your mortgage is paid off for a fixed-rate mortgage. Most of the first payments go toward interest, but the payment remains the same – $599.55
In a full amortization schedule, the interest payments continue to go down while the principal payment goes up.
I know I have repeated this several times now, but if you don’t get the hang of this, you might be making the wrong payments.
If most of your mortgage payment still goes to your loan servicer or lender over time, then you’d simply be making them rich without necessarily clearing your debt.
Continually refinancing your mortgages, would keep piling up more interest debts on your loan.
When you refinance your mortgage into the same loan type you would only be extending the loan amortization period of the mortgage and also the loan term.
The longer the life of your loan lasts, the more interest you would pay.
To avoid this, refinance with a loan that has a starter term. A 10 – 15-year mortgage for instance.
What Is A Fully Amortizing Payment?
A fully amortized mortgage or fully amortizing payment is a scheduled loan payment that ensures that a loan would be completely paid off at the end of the loan’s term.
What Is An Interest-Only Mortgage?
In an interest-only mortgage, the borrower pays only interest for a certain time before continuing with making principal repayments on the loan.
The difference between a fully amortized mortgage and an interest-only mortgage is that in the latter, you pay only interest for some time, then the principal after that. For a fully amortizing payment, you pay both interest and principal at the same time, during your monthly mortgage repayments.
When Do My Mortgage Payments Start?
Your rent becomes due on the first day of the month, which means you pay in advance. For mortgages, you pay in arrears.
If you closed your home loan on Jan 14, Your mortgage payment starts counting from From Feb 1, which means that your next payment would be due by March 1.
Mortgage payments are this way because your closing costs already contain the interest rates for the remaining days of the closing month. In this case, for the remaining days in January.
How Are Mortgage Payments Calculated?
Mortgage payments are calculated using the mortgage components- principal, interest, taxes, and insurance. You can estimate how much monthly mortgage payment you are to make using the estimate given below.
For instance, the daily interest on a $100,000 mortgage with a 20% down payment is $16.44. It will result in a monthly payment of $599.55 under a 30-year fixed-rate mortgage and a 6% interest rate.
To calculate this, multiply the loan value which is $100,000 by the 6% interest rate, then divide by 365. This gives you $16.44.
Since the mortgage closed on Jan. 14, you are ordinarily owing your lender $279.45 for the remaining 17 days of the month. This amount is included in the closing costs.
The next monthly payment, the full monthly payment of $599.55, is due on March 1 for the February mortgage payment.
This information is documented in the loan estimate and closing disclosure and given to you on the closing date.
Conclusion: An Idea On How Your Mortgage Is Paid Off Over Time
Learning how your mortgage is paid off over time is very essential to keeping track of the mortgage payment you owe your lender.
How long will it take you to pay off your mortgage? How much would it cost you to completely finance your home purchase?
Understanding the mortgage amortization schedule would help identify all these and more.