Mortgages
Buying a home is one of the biggest financial decisions people make in their lives. It requires taking on a large amount of debt in the form of a mortgage loan. Learn what goes into a monthly mortgage payment and what it looks like to pay off this huge loan over time.
There are many ways mortgage calculations might surprise you. For example, did you know that a $500,000 loan with a 5.5% mortgage interest rate will cost you more than $1,000,000 over 30 years? Did you also know that after one year of monthly payments you will have only paid off about $7,000 in principal? Use the mortgage calculator to see how much interest you're actually paying on your current or future mortgage. Check out the charts and mortgage amortization schedule below to see what it looks like to pay off a mortgage over time.
What is a mortgage?
Mortgages are loans specifically meant for buying real estate, like a house. Since it is nearly impossible to save enough money to buy a house outright, people pay only a portion of the sale price up front (a down payment) and take out a loan to pay off the rest (a mortgage). A bank lends you the money to purchase the house, and then you pay back the bank (plus interest!) over the course of many years. Your monthly mortgage payment is determined by the amortization schedule. Amortization schedules can be complicated, mathy, and confusing at first, but let's simplify it so that you understand what goes into your fixed monthly payment.
What is mortgage amortization?
Mortgage amortization is the process of paying off a mortgage loan over time through a series of fixed monthly payments. These payments are calculated based on the loan amount, the mortgage interest rate, and the loan term. The fixed monthly payment is divided into two parts:
- Principal: This part of your fixed monthly payment goes toward paying down the original loan amount. As more principal is paid, your stake (equity) in the house grows and you owe less money to the bank.
- Interest: This part of your payment is the cost of borrowing money, or in other words, that extra amount that you are paying the bank since they loaned you the money to buy the house.
The amount of principal and interest you pay changes every month, but your monthly payment stays the same. When you first start paying the loan back, the fixed monthly payment is mostly made up of interest. This is because your loan balance is at its highest point, and since interest is calculated based on this balance, the interest payment is large while the balance is large. Additionally, the structure of amortization schedules helps lenders cover the risk of giving you money, as they are making more money up front instead of waiting the whole 30 years for you to pay them back.
Now that you have a better understanding of mortgage loans, amortization schedules, and fixed monthly payments, let's look at how you actually get a mortgage and finally buy a house!
How to get a mortgage
Buying a home and applying for a mortgage can be intimidating, especially for first-time home buyers. There are a lot of steps, but here is a simple breakdown of the home-buying and mortgage lending process:
- Determine your budget. Figure out how much money you can afford to borrow (i.e. how large of a mortgage you will take out). This depends on factors including your income, expenses, and how much you already have saved for a down payment.
- Get mortgage pre-approval. Before you start house hunting, it may be a good idea to get pre-approval by a mortgage lender. This means that a potential lender will review your financial situation and tell you how much they'd be willing to lend you. Having mortgage pre-approval will also indicate to potential sellers that you are a serious buyer who is qualified to be looking at their house.
- Find a home! The most obvious but also one of the hardest steps. Once you have pre-approval, look for homes that fulfill your needs but are also within your budget.
- Make an offer. When you find a home you like, make an offer to the seller. If they accept, congrats! Next comes a lot of paperwork.
- Apply for the mortgage. After your offer is accepted, you will fill out a mortgage loan application. Look for a mortgage broker or lender who you trust and who offers a competitive mortgage interest rate (this may or may not be the lender who gave you pre-approval). When you find a lender you like, you will provide documentation that verifies your income and credit history.
- Get a home inspection and appraisal. Your lender may require an inspection to ensure the home is in good condition, and an appraisal to make sure the home is worth the loan amount they are lending to you.
- Close on your home. If everything checks out, you will go through the closing process. This is when you will sign the real estate transaction documents, pay any closing costs, and take official ownership of the home.
- Make monthly payments and build equity! After closing, you will start making your monthly payments. These payments include the principal and interest, along with any property taxes and homeowners insurance, and possible mortgage insurance as well. Over time, as you keep making payments, you pay more principal on your home and in turn you build equity. Eventually you'll own your home outright!