If you’ve ever given any thought to buying a home, then you probably know that a mortgage is a type of loan designed for the purchase of a property. You’re also likely aware that people who use mortgages to buy homes make monthly payments over the lifetime of the loan to repay their obligation, but do you really know how mortgage payments work? It may get a little complicated, but a basic understanding of what’s involved in mortgage payments can be tremendously valuable. In fact, it could help you identify opportunities to enjoy substantial savings over the life of the loan.
How Mortgage Payments Work
The Building Blocks of a Mortgage Payment
When exploring how mortgage payments work, it helps to understand the building blocks that make up your mortgage payment. As Investopedia reports, there are four factors that shape the average mortgage payment:
- Principal: The principal is the amount of money borrowed, which must be repaid.
- Interest: Interest is the price of borrowing. Generally speaking, a lower interest rate means that you’ll pay less for the use of the funds over the life of the loan. A higher interest rate means that borrowing will cost you more.
- Taxes: Real estate and property taxes are assessed by government agencies, but lenders often play a role in collecting them. In many cases, your yearly property tax bill is broken down into monthly installments and added to your mortgage payment. Then, your lender places the funds in an escrow account until it’s time to pay the bill.
- Insurance: Premiums for mortgage insurance, and in some cases property insurance, may also be added into the monthly mortgage payment, held in escrow, and paid by the lender.
Amortization: A Matter of Interest
When you have a mortgage, you’re charged interest each month on your loan’s remaining principal balance. Part of each month’s payment will go toward paying off the principal and part will go toward paying off the ever-accumulating interest. However, the portions of your payment devoted to these obligations change during the course of the loan thanks to a process called amortization.
As Policygenius explains, in the early days of a home loan, a bigger chunk of your monthly payment goes to paying interest, and a much smaller amount is put toward the principal. Over time, this division shifts; as less is earmarked for interest, a bigger portion goes to paying off the principal. If you’d like to see a breakdown of how your payment is applied, the easiest way is to look at an amortization table. However, if you don’t want to juggle all those numbers, just remember that payments made early in the mortgage are mostly interest, so it takes time to start making a serious dent in the principal balance if you stick with the standard payment plan.
Saving Money with Mortgage Payments
With a home loan, interest is continually assessed on the remaining principal balance. Reducing the balance means you’ll accrue less interest, but it takes time because the bulk of your early payments is applied to the interest that you owe rather than the principal. How can knowing that help you save money? While the amortization schedule is beyond your control, you can request that any extra funds that you pay be put toward the principal. This simple step will reduce the remaining principal owed faster, which reduces that amount of interest and can save you thousands of dollars over the life of the loan.
How can you pay extra? The Balance suggests adding a little extra to your payment each month. Alternately, you could make a lump sum payment when you have cash available to do so. Whatever approach you take, be sure to specify that the extra money should be put toward the principal.
At PrimeLending of Wichita, we value transparency. Our loan experts offer personal guidance as well as easy communication and clear, concise answers to your questions so that you always know where you stand. When you’re ready to buy or refinance your home, reach out to us to discover your best loan option.