Most people cannot afford to pay the full price for their home at the time of the purchase. Instead, they take out a mortgage from a bank or another lender. This covers the cost of the home beyond the down payment. The homeowner then will pay off the mortgage in monthly installments over the term provided in the agreement. If they fail to keep up with their monthly payments, the lender will have the right to foreclose on the home unless they reach an alternative solution with the homeowner, such as a loan modification.
Monthly payments will involve paying off the principal on the mortgage and the interest on the loan. The principal is the basic amount that you owe on the mortgage, while the interest is the rate charged by the lender for making the loan. It is calculated as a percentage of the loan amount. Making payments on the principal builds equity in your home, but making payments on the interest does not. While the principal and the interest form the bulk of the monthly payment, it usually also covers payments for property taxes and homeowners’ insurance. If you lapse in your payments in either of these categories, the lender has the right to make these payments for you and then seek reimbursement.
The Balance Between Principal and Interest Payments
During the course of a fixed-rate loan, which is the standard type of loan, the total monthly payment for principal and interest will not change unless you modify the terms of the loan. However, the breakdown between the principal and the interest will change. At the outset of the loan term, your outstanding balance is relatively high, which means that you owe significant interest. As a result, a large amount of the monthly payment is allocated to paying off the interest. Once you have made many payments, the balance on the loan will be lower, and your interest also will be lower. This means that a larger percentage of the monthly payment will go toward paying off the principal.
Paying Off Your Mortgage Early
Some homeowners consider paying off the mortgage in advance to get rid of this obligation. This may or may not be a smart idea, since you may need to account for other substantial payments as well, such as costs related to your children. If you choose to pay off your mortgage early, you can ask the lender to refinance the loan so that it has a shorter term with a larger monthly payment. This should reduce the interest rate as well, although it will lead to extra closing costs.
Talk to the lender before paying off a mortgage early or making extra payments to fully understand the ramifications, such as early payment penalties.
Rather than formally adjusting the loan terms, you can also make larger payments than required each month. You should make sure to let the lender or mortgage servicer know about the larger payments so that they can apply the payments correctly. You will want to check your statements to make sure that the extra funds were processed. This can be a good option if you get a bonus, a tax refund, or another one-time windfall.
You can also make one extra monthly payment each year, or 13 payments for every 12-month period. In other words, if you can save one-twelfth of your monthly payment amount each month, you can add those amounts together and pay the combined amount at the end of the year.