Understanding Your Mortgage Payment
When you’re shopping for a mortgage, there’s a plethora of jargon and loan terms that may confuse you.
The whole process of obtaining a mortgage can be more than stressful. You may feel like you need help understanding your mortgage payment and how mortgages actually work in general. We’re here to help you figure that out.
Mortgage Payments 101
For starters, we should go over some of the trickiest terms for mortgage novices. We all know that a mortgage is essentially a loan from a lender (usually a bank) that lets you make monthly payments on a home. But what about some of those other terms that may be difficult to understand? Some of those might include:
- Principal – The principal of the mortgage is the amount of money you borrowed from the lender and the amount you have to pay back. A portion of your monthly mortgage payment will go to paying down the principal.
- Interest – Interest is a percentage of the principal that is paid to the lender over the course of the mortgage period. Lenders are typically taking a risk by offering credit to a borrower, and the interest allows them to earn money on that risk. Interest rates are set by the lender and are also paid back monthly by you.
- Amortization – Amortization is simply the amount of time in which the mortgage (including interest) will be repaid. This is usually somewhere between 10 and 30 years. Amortization can affect the amount you pay each month (e.g. a 15-year loan will cost more each month than a 30-year loan with the same principal and interest rate).
- Term – The term is the amount of time most mortgage conditions (including interest rates) are in effect (usually between 6 months and 10 years).
- Payment schedule – This is how often you make a payment (usually monthly, bi-weekly, or weekly).
Different Types of Mortgage Rates
If you want to know how to understand mortgage payments, then you need to understand interest rates. There are several different types of interest rates that you can use for the duration of the mortgage period. Three of these include:
For most people, a fixed-rate mortgage is the most attractive option, because your interest rate and monthly payment will be the same across the entire term of the loan. For instance, if you sign on the dotted line for an interest rate of 3.2% on a 25-year loan, then you’ll be paying 3.2% interest for 25 years (or however long it takes for you to pay off the loan). In most cases, your payments will also be fixed. Unfortunately, if market rates drop lower than 3.2%, you’ll still be stuck with that interest rate.
That’s where variable interest rates come in. Variable rates fluctuate with standard market interest rates. That is, you can start a loan with an interest rate of 3.2%, but if market rates go down to 2.6%, then your interest will, too. As you can imagine, however, market interest rates can increase, leaving you with a higher payment and interest rate.
Market conditions also affect adjustable rates, but, in this case, interest rates and monthly payments can vary based on market conditions. If there’s some indication that market conditions are going to trend downward, then an adjustable rate may be right for you.
Can You Pay Extra on a Mortgage?
If you want to reduce your amortization period, then your best bet is to usually pay extra money into the mortgage. But, make sure you read the fine print. Paying off mortgages early can come with a monetary penalty. To avoid that, make sure you understand the difference between open and closed mortgages.
An open mortgage gives you the freedom to make extra payments and even pay off the entire loan early without a penalty from the lender. That means you won’t have to pay off exorbitant interest sums either. You can also use an accelerated payment schedule to achieve this same goal. These are usually weekly or bi-weekly payments that are made consistently over the course of a year. You end up paying slightly more each month which effectively reduces the amortization period and the amount of interest you have to pay.
A closed mortgage, on the other hand, locks you into a monthly payment and interest rate for the entire amortization period. This can be helpful if you want to know what you’re paying in any given month no matter what.
Knowing your mortgage payment is just as important as owning a home in itself. Without a good understanding, you may be locked into terms that you didn’t really want. It’s always a good idea to go over the mortgage conditions with your mortgage broker to ensure that’s it’s not one-sided.
What you should do now
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