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LESSON 2: HOW MORTGAGES WORK
(continued from previous page)
The breakdown of each
payment (the amount that goes toward principal, interest, etc.)
changes over time because mortgages are based on a repayment formula
called amortization.
That's a fancy term meaning the lender spreads the interest you
owe on the mortgage over hundreds of payments so that the overall
loan is as affordable as possible.
How
does amortization work?
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Here's
how the principal and interest change over the life of a loan
(30-year, 7.5% fixed-rate mortgage of $150,000)
|
| Payment number
|
Principal
balance |
Payment
amount |
Interest
paid |
Principal
applied |
New
balance |
|
1
|
$150,000 |
$1,048.82 |
$937.50 |
$111.32 |
$149,888.68
|
| 60 |
$142,086.93
|
$1,048.82 |
$888.04 |
$160.78 |
$141,926.15
|
| 120 |
$130,426.14
|
$1,048.82 |
$815.16 |
$233.66 |
$130,192.48
|
| 240 |
$88,851.22 |
$1,048.82 |
$555.32 |
$493.50 |
$88,357.72 |
359
|
$2,078.14 |
$1,048.82 |
$12.99 |
$1,035.83 |
$1,042.3 |
|
Source: Bankrate.com
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On a 30-year, $150,000 mortgage with a fixed
interest rate of 7.5 percent, a homeowner who keeps the loan for
the full term will pay $227,575.83 in interest. (Quick, take another
breath.) The lender can't possibly expect that person to pay all
that interest in just a couple of years so she spreads the interest
over the full 30-year term. That keeps the monthly payment at $1,048.82.
But the only way to keep the payments stable is to have the majority
of each month's payment go toward interest during the early years
of the loan. Of the first month's payment, for instance, only $111.32
goes toward principal. The other $937.50 goes toward interest. That
ratio gradually improves over time, and by the second-to-last payment,
when we're all driving hovercars and have colonized the moon, $1,035.83
of the borrower's payment will apply to principal while just $12.99
will go toward interest.
Just starting to loan shop? Use this calculator
to figure your mortgage payment, play "what if" scenarios
and even create an amortization table. See how your loan will play
out over the long haul.
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