Buying your first home?

You may be asking: What’s a mortgage loan and how does it work?

A mortgage loan is given by a bank or lending institution to finance a property. When you purchase a home with a mortgage loan, you agree to repay the money with a specific interest rate.

A mortgage loan is a secured loan, which means a borrower promises collateral to the bank if they don’t make payments (in this case, the home).

There are a variety of mortgage loans available to people, including:

• Fixed-rate mortgage
• Adjustable rate mortgage
• Balloon mortgage
• Federal Housing Administration (FHA) mortgage
• Veterans Affairs (VA) mortgage

Some of these loans also have terms that vary – a fixed rate mortgage with a 15-year term vs. a 30-year term, for instance – so talk to your lender about your options.

What does principal mean?

A mortgage has two components:

1. Principal: the exact amount of money you borrow from your lender to purchase your home.
2. Interest: the extra money you are charged to borrow that money (the principal).

What makes up a mortgage payment?

Mortgage loans are typically paid back in regular installments, most often monthly payments.

Your monthly payment is set up to pay back the principal amount, but part of it also goes toward interest on your loan. In the early years, more of your payment will go toward interest; then you’ll start paying more principal in the later years of your loan.

You may have other pieces to your loan payment, if you choose to include them:

• Property taxes – you can set aside money for your taxes in an escrow account, and your lender will pay your tax bill with this money.
• Homeowners insurance – Insurance protects you against accidents or disasters. You can also choose to collect your insurance premiums into your escrow account and have your lender make payments to your insurance provider.

(Important to note: Some loan types and loan situations may require you to escrow your taxes and insurance.)

• Private mortgage insurance – PMI is often required by traditional lenders when your down payment is less than 20%. If you have PMI, this fee will also be included in your monthly mortgage payment.

The components of your monthly mortgage payments are often called “PITI”: principal, interest, taxes and insurance.

Payment calculations

To calculate your mortgage payments, you’ll need to consider several things, including how much your down payment is and your overall PITI.

Your lender will show you the amortization schedule for your mortgage with a breakdown of the exact payment amount.

With this schedule, you can see how much interest and principal you’re paying and how your loan balance will decrease over time.

Should I make extra payments on my mortgage loan?

There are pros and cons to making extra payments on your loan. If you won’t be in a house for very long, it may not make sense financially to tie up cash into your mortgage. It also won’t lower your monthly payments to pay extra.

On the other hand, making extra payments brings two great benefits:

1. You can reduce the money you pay in interest. You can choose to make additional payments on only the loan principal, lowering your balance and the interest charged on that balance.
2. You can pay off your loan more quickly. You’ll have fewer loan payments to make over the life of your loan because your balance is decreasing faster. And eventually you’ll own your home outright!

If you have the financial flexibility to make extra payments against your mortgage loan, talk to your lender to see what kind of payment schedule is best for you.

Questions about mortgages? Contact me at INB!