Next to mortgage rates, the monthly payment is perhaps the most negotiated aspect of a Connecticut home-loan deal. After all, keeping your housing bill low can make your finances more manageable, reduce your chances of losing your property due to foreclosure, and build your credit steadily.
However, any honest mortgage lender will tell you that not understanding how amortization works can jeopardize your future financial goals. You probably do not plan to hold on to your home loan until it matures and want to grow your home equity more quickly.
The effectiveness of your strategy is limited to your knowledge of mortgage rates and payment composition. It is not exactly straightforward, so it is imperative to get your facts right before negotiating the terms of your loan.
Here, let us dispel the most pervasive misconceptions about monthly mortgage payments.
Each Monthly Payment Is Divided Into Principal and Interest
A monthly mortgage payment is never made up of just the principal and the interest. You also have other expenses, such as the property tax and the insurance, to worry about. In other words, a typical mortgage payment chart looks more like a pizza sliced into four and less than a burger cut in half.
Furthermore, an interest-only mortgage does not include principal reductions during an initial period; hence, the name. This loan program is extremely attractive, for it involves conveniently low monthly payments.
But then again, interest-only mortgages are generally catered to investors, buyers who intend to purchase properties and flip them for resale. Nevertheless, ordinary homebuyers, those who purchase properties to live in them, might benefit from an interest-only mortgage when they are still selling their previous houses.
Principal and Interest Have Equal Slices of the Pie
Unlike other installment loans, mortgages have fluid principal-interest payment composition. The principal and interest portions change over time, and the former will not exceed the latter until nearly the nearly point of the term. In short, most of your early payments will apply toward the interest, which, in turn, slows the reduction of your overall principal balance.
Why is the math done this way? There are two main schools of thought at play.
First, lenders want to pocket as much interest as possible quickly to reduce their exposure to any financial loss in the event of delinquency. Since prepayment penalties, in general, are enforceable only in the first three years of the loan, lenders just have to 36 months to turn a decent profit.
Second, an average American repays a mortgage more or less eight years after it was consummated. Again, lenders could no longer charge a prepayment fee after year three, so they do not gain anything when the principal is paid off ahead of schedule.
Monthly Payments Remain the Same Until the Loan Term Ends
Predictability is the most attractive characteristic of fixed-rate mortgages. In theory, their monthly payments are constant, even if their principal and interest portions are ever-changing.
However, you can experience a monthly payment reduction at some point. If the property tax rate in your area changes down the road, your monthly mortgage payments might move in the same direction. When you ditch your private mortgage insurance or manage to find a more affordable homeowners insurance, your monthly payments will go down accordingly.
Mortgage amortization is not rocket science, but it is not a concept you can wrap your head around without dedication. The better you can predict how your monthly payments can change in the future and how fast they can reduce the overall balance, the better you can pick the right strategy for your financial goals.