How Mortgages Work
When you apply for a mortgage, you quickly become immersed in a new language. It can all sound very foreign at first, but we’ll boil down some basics here about how mortgages work and language that is commonly used.
First, let’s look at what you really are paying when you make a mortgage payment. These components commonly are referred to as PITI:
- Principal – This is the amount of the monthly payment that pays off your actual loan amount.
- Interest – This is what you are paying to borrow the money for your home. It is calculated based on the interest rate, how much principal is outstanding and the time period during which you are paying it back. At the beginning of the loan repayment period, most of your payment actually is going toward interest, with a small portion going against paying down the principal. Over time this will reverse and more of your payment will go toward reducing the loan balance.
- Taxes – Most homeowners will pay their annual property taxes in periodic increments to the lender (e.g., quarterly).
- Insurance – Lenders will require homeowners insurance, so some of your monthly payment will be allocated to your insurance. You sometimes will also have to pay a mortgage insurance premium.
Taxes and insurance are held in escrow on your behalf. This means the lender collects these amounts for you and pays them when the bills are due.
Sample Amortization Tables
U.S.MortgageCalculator.org offers an easy way to see how mortgage payments get applied to the components just described. You can use this calculator (also available as an Android app) to plug in numbers for your own mortgage.
Plug your own numbers in the amortization calculator and scroll down to see how much you actually will pay over the life of your loan.
Did the number shock you?
When it comes to reducing how much you pay over the life of your loan, make simple reductions in your outstanding principal. Try it with the calculator to see how just adding $20 a month can reduce the overall cost of your loan repayment.