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Understanding your mortgage is one of the most important financial decisions you will ever make. Here is everything you need to know about how mortgages work, what your monthly payment covers, and how to pay less interest over time.
Every mortgage payment you make is split between two things: principal and interest. The principal is the actual loan balance you owe. The interest is the fee the lender charges for lending you the money.
In the early years of a mortgage, the vast majority of each payment goes to interest. As you pay down the balance, more of each payment goes toward principal. This is why the first decade of a 30-year mortgage barely dents what you actually owe.
Amortization is the process of spreading your loan repayment over a fixed period through equal monthly payments. Even though your payment stays the same each month, the split between principal and interest shifts gradually over time.
Four things determine your monthly mortgage payment: the loan amount, the interest rate, the loan term, and whether you have mortgage insurance. A lower rate or shorter term increases your payment but reduces total interest dramatically.
Making even small extra payments directly toward your principal can shave years off your mortgage and save tens of thousands in interest. An extra $200 per month on a 30-year mortgage can cut 4 to 6 years off your repayment timeline.
The key is to specify that the extra payment goes toward principal, not toward your next month's payment. Check with your lender on how to do this properly.
A fixed rate mortgage locks in your interest rate for the entire loan term. Your payment never changes, which makes budgeting straightforward. A variable rate mortgage starts at a lower rate but can change periodically based on market conditions.
Put these concepts into practice with our free calculator and see the numbers for your own situation.
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