Having a mortgage on a home is a necessary part of today’s world, but it’s hard to ignore how expensive they can be. Interestingly, the term “mortgage” actually comes from the French word “mort gage,” which translates to “death pledge.” This name reflects the never-ending debt that we sign up for every time we finance a home.
In this blog post, we will cover how interest works on a mortgage and how much it can cost you over the life of the loan. Don’t worry, the math isn’t rocket science, but having a loan calculator can make it easier to understand. There are plenty of loan calculator apps and websites available that can help you with the calculations.
The Cost of Interest Over Time
Let’s take an example to understand how interest adds up over the life of a mortgage. Suppose you finance a home for $300,000 at a fixed interest rate of 5% for 30 years. According to the loan calculator, your monthly payment will be around $1,600 for the next 360 months.
If you don’t make any extra payments, you will end up paying almost $280,000 in interest over the life of the loan. This amount is nearly double what you originally paid for the house, and it’s not an appealing prospect.
However, if you opt for a 15-year mortgage instead, you will have higher monthly payments but a lower interest rate. Typically, the interest rate on a 15-year mortgage is about 1% lower than that of a 30-year mortgage. This one percentage point alone can save you a significant amount of money in interest.
For example, if you can afford a 15-year mortgage on the $300,000 house at a 4% interest rate, you’d end up spending about $100,000 in interest. This is significantly less than the $280,000 you would pay with a 30-year mortgage. It’s clear that choosing a 15-year mortgage can save you a lot of money in the long run.
One of the reasons a 15-year mortgage costs you less in interest is because it forces you to pay more principal towards your home every month. The more principal you build on your house, the less you’ll pay in interest.
Let’s take a look at how the amortization schedule works. This schedule breaks down your interest and payments over the life of the loan. We’ll use the example of a 30-year mortgage to illustrate this.
In the first month, out of your $1,600 monthly payment, only $360 will go towards the principal of the loan, while the rest will go towards interest. As you progress through the loan, you’ll notice that the amount going towards principal gradually increases, while the interest reduces.
By month 60, you’ll be paying more towards the principal and less in interest. This trend continues throughout the life of the loan. As you pay more towards the principal and owe less, the interest can only charge you based on what you owe. Therefore, every month becomes more favorable for the borrower as long as the monthly payments are made.
It’s important to note that it takes five years to reach this point on a 30-year mortgage. By month 300, the interest and principal have significantly flipped on the loan. This milestone is reached after 25 years of paying off the mortgage.
The Power of Extra Payments
If you have the means, making extra payments towards your mortgage can be extremely beneficial. The sooner you put extra money into the loan, the more it will compound over time and save you even more money in the long term.
Extra payments work like a snowball effect. As you pay extra towards the loan, the interest compounds on itself year after year. This compounding effect can lead to substantial savings over the life of the mortgage.
If you want to explore different scenarios, make sure to use a loan calculator. Playing with different numbers can help you understand the impact of extra payments on your mortgage. You might be surprised to learn how much money you can potentially save.
Understanding how mortgage interest works is essential for homeowners. By choosing the right mortgage term and making extra payments when possible, you can save yourself a significant amount of money in interest payments. Remember to use a loan calculator to explore different scenarios and make informed decisions about your mortgage.
Hopefully, this blog post has shed some light on the basics of mortgage interest and how it can affect your finances. If you found this content helpful, consider subscribing to our channel for more informative videos on various financial topics. Your financial well-being is important to us, and we’re here to provide you with the knowledge you need to make informed decisions.