Many people aren’t familiar with finance lingo. This post will break down the various terms and concepts that define what a mortgage payment is, and how these payments are calculated.
Mortgage terms to know
As we said before, there’s tons of jargon to understand, so it’s important to start with a few definitions and key terms.
Mortgage – A term describing a type of loan where a mortgagee (whomever you get your loan from) gives you (the mortgagor) the money to purchase a home, and then you pay for it over an agreed-upon period.
Principal – The principal is the amount you owe and have to pay back. For example, if you borrowed $200,000 to buy a home, this is the principal.
Interest – What the mortgagee or lender charges for lending money, calculated from an agreed-upon rate and the size of the principal.
Term – The fixed repayment schedule over a period of time.
Mortgage Insurance – Depending on the type of loan you take out, there will likely also be insurance premiums that must be paid each month to insure your loan.
Escrow Account – An account that stores money to pay both property taxes and homeowners insurance. The money that goes into this account is usually a part of the monthly payment. Escrow is usually not required if you are able to put a 20% down payment on a home.
Interest vs. principal
This part is so important, we gave it its own section. The relationship between the amount of interest you pay and your principal depends on varying factors. For example, depending on whether you picked a fixed or variable rate mortgage, your interest payments might change depending on the rate in a given year. Many people choose a fixed rate mortgage.
Each month you pay a portion of your principal and a portion of your interest. When you start making payments, interest payments will be much higher than principal payments. But over the life of the loan, your principal payments will become larger as you’re charged less interest (because the principal the loan is being calculated from is decreasing).
Making the mortgage decision
Now we can take a look at a mortgage calculator. First Option has a good one. It’s pretty simple: Enter the loan amount, your annual interest rate, and the length of your loan. You’ll get a pretty good idea of the amount you’ll pay, and you can see that by choosing a shorter mortgage term or adding more money to your payment each month, you’ll end up saving money on interest payments.
If you’re curious about the actual calculation behind the calculator, here is is:
Principal + interest + mortgage insurance (if applicable) + escrow (insurance and tax) = total monthly payment
We hope this breakdown of the mortgage payment calculation was helpful. If you’d like more information about how the process works, get in touch, or let us know if you have any questions on Twitter or Facebook.