The typical mortgage loan has a 30-year term, and interest is paid on the outstanding balance before the loan is completely repaid. A homeowner should have an notion of how much total interest will be paid on a mortgage and what portion of each monthly payment goes to pay the interest.
Function
A fixed-rate mortgage is a loan with equal monthly payments that ends in the mortgage being paid off at the end of the mortgage period. A 30-year mortgage may have 360 equivalent payments consisting of interest and principal reduction. The interest rate on a mortgage is an annual rate that is placed on the outstanding mortgage balance. The amount of interest declines, as the mortgage principal balance is repaid. The outcome is that premature payments in a mortgage are mostly interest with a smaller amount going toward principal reduction; since the principal reduces, a greater portion of each payment goes toward the principal.
Significance
The long term nature of mortgage loans causes a large amount of interest being paid if a mortgage is paid off entirely through the scheduled monthly payments. By way of instance, a $400,000 mortgage at 6 percent has a monthly principal and interest payment of $2,398. Multiply the payment intervals 360 and the total to pay off the mortgage is more than $860,000. This means the total interest paid would be more than $460,000. An internet mortgage calculator such as that supplied at Bank Rate will provide the specific amount of interest paid on a loan.
Identification
The amount of interest with each monthly mortgage payment is the annual interest rate divided by 12, multiplied by the outstanding mortgage principal. Employing the mortgage case above, the annual rate of 6% divided by 12 provides a monthly rate of 0.5 percent. Multiply the $400,000 original loan amount occasions 0.5 percentage –0.005–to find the attention on the initial payment, which can be $2,000. After 5 decades, the loan was paid down to $372,200. For the upcoming monthly payment on this principal amount, the interest is $1,861 of the $2,398 combined principal and interest .
Possible
Since the interest on every monthly payment is based upon the outstanding loan balance, paying additional principal decreases the interest paid on the next payment and each next payment. Homeowners that are considering paying off their houses early may utilize this effect. Adding extra principal amounts into the monthly payment may have a significant impact on reducing the opportunity to repay a mortgage and the total interest paid.
Effects
One way to find the effects of greater principal payments on mortgage interest is to compare a 15-year mortgage into a 30-year mortgage. The $400,000 mortgage with a 6% rate and a 15-year term could have interest and principal payments of $3,375. The interest on the initial payment is exactly the same as with all the 30-year mortgage: $2,000. However, the 15-year mortgage has nearly $1,000 more likely to reduce the principal balance with every payment. The outcome is the 15-year mortgage is paid off with a total of $208,000 in interest paid compared to $463,000 on a 30-year mortgage.