A mortgage is a long-term loan given by a bank or other lender to help the borrower purchase a house. The lender gives the borrower the money needed to buy the house and the borrower makes monthly payments to pay the lender back. These monthly payments cover the amount of the loan (the principal) as well as interest and other fees.
In a fixed-rate mortgage, the interest rate and the monthly payment will remain the same for the life of the loan. In an adjustable rate mortgage, the interest rate will fluctuate based on market forces and this can cause the monthly payment to change. Regardless of the type of mortgage, the monthly payment is largely determined by the length of the loan (term), the amount (principal), and the interest rate.
The most common term for mortgages is 30 years. However, 15-year mortgages are also popular because they allow the borrower to pay off the mortgage quicker. A longer loan will result in lower monthly payments, but will also result in more interest being paid over the life of the loan.
The principal is the amount of the loan. Modern mortgages are calculated so that the entire amount of the loan is paid off through the monthly payments. Therefore, the larger the amount, the larger the payments will be.
The interest rate has a direct impact on the size of the mortgage payment; the higher the interest rate, the higher the monthly payment will be.
Balance of principal vs. interest
Part of the monthly payment is applied to the principal and part to the interest, but these portions will change during the life of the loan. At the beginning of the loan, most of the monthly payment goes toward paying off the interest. By the end of the loan, most of the interest has been paid off, so the bulk of the monthly payment is used to pay down the principal.
In a 30-year fixed rate mortgage with monthly payments of $599.55, the division of principal and interest may look something like this:
Mortgage table from: http://www.investopedia.com/articles/pf/05/022405.asp#ixzz27Ozbel9q
If the homeowner chooses to pay more than the minimum monthly payment, the additional money will be applied toward the principal. This can help pay off the loan earlier and will reduce the total amount of interest paid. However, some mortgages require the homeowner to pay a penalty for paying off the mortgage early. Homeowners should check with their mortgage consultant for details on their situation before making a decision on paying the loan early.
Taxes and Insurance
In addition to paying the principal and interest, many mortgages also include some taxes and insurance.
All homeowners are to pay certain local and state taxes based on the value of their home. Often these taxes are paid as part of the monthly mortgage payment and the lender pays the taxes collected through these payments to the city and state.
Property insurance protects the home and the belongings in a home from disasters such as fire, earthquakes, theft, and other dangers. Like real estate taxes, property insurance is generally paid with the mortgage payment and the lender pays it to the insurance company. After the mortgage is paid off, the homeowner pays the taxes and property insurance directly to the government and the insurance company, respectively.
Some borrowers are also to pay private mortgage insurance. This is most common when the down payment is less than 20% or if the borrower has a low credit score. This insurance protects the lender in case the borrower does not repay the loan.