How Are Mortgages Calculated?
Mortgages are calculated based on the amount of money you borrow to purchase your home, or the principle, the amount of interest you agree to pay in order to borrow the money and on the type of mortgage you select. Mortgages are calculated into monthly payments over the life of the loan agreement.
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Fixed Rate Mortgage
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If you are scheduled to pay the same amount of money each month on your mortgage until the principle is paid in full, you have a fixed rate mortgage. The monthly payments are calculated based on a fixed interest rate, which is compounded onto the principal annually and divided into monthly payments. These mortgages are designed to pay the bulk of the interest first and do not begin to significantly reduce your principal until the last several years of your mortgage loan term. The longer the term of your loan, the more interest you will pay.
Adjustable Rate Mortgage
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Adjustable rate mortgages are calculated based on a fixed interest for a defined number of years which translates into a fixed mortgage payment, similar to the fixed rate mortgage. At a predetermined point in the term of the mortgage, the interest rate will adjust to reflect then current interest rates which will cause your payment to fluctuate. For example, if you have a 10/1 adjustable rate mortgage, the amount of principal and interest you pay each month will be the same for the first 10 years. Beginning in the eleventh year and each successive year, your mortgage payment will be calculated based on the outstanding principle balance and on the current interest rates at that time. Your monthly payments will adjust to accommodate the new interest rate.
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Balloon Mortgage
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The average term for a balloon mortgage will vary based on the lender and on your ability to repay the loan. Most balloon mortgages run for five to seven years. During that time, your mortgage payments are fixed and calculated based on the interest rate you agree to pay and on the principle balance that you owe. At the end of mortgage term, the outstanding principle balance is due in full as one lump sum payment.
Interest Only Mortgage
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An interest only mortgage is calculated based on the interest rate you agree to pay for a predetermined amount of time, usually five to seven years. Your monthly payments are for interest only; you are not reducing your principle at all during the term of an interest only mortgage. At the end of the mortgage term, you must either pay the principle in full or refinance your mortgage.
Taxes & Insurance
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Many mortgages also include homeowner's insurance, property taxes and private mortgage insurance, PMI, calculated into the monthly payment. The annual amount of your property taxes and homeowner's insurance is divided into 12 monthly payments and added to the interest and principle portion of your loan. Your mortgage lender then pays the taxes and insurance for you. You are not paying interest on the tax and insurance portion of your mortgage. Lenders may require PMI when a buyer borrows more than 80% of the home's value.
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