Mortgage loans are typically amortized over 30 years. What does this mean?

A borrower will pay a combination of principal and interest payments over a 30 year term. The interest is front loaded, so for approximately the first ½ of the loan term, the borrower is paying more interest than principal. Loans typically do not last the full 30 years, as homes are sold or loans are refinanced. By front-loading the interest, lenders are assured profit prior to the loan being paid off.

Example: assume a borrower obtains a $300,000 loan at 4.5% on a 30-year fixed mortgage. The monthly principal and interest payment is $1,520.06. The first payment consists of $395.06 principal and $1,125 interest. The lender collects the interest and the loan is paid down by the principal payment. The second payment consists of $396.54 principal and $1,123.52 interest. Each payment incrementally increases the amount of principal and decreases the amount of interest. It isn’t until the 16th year when the amount of principal paid exceeds the amount of interest paid.

In fact, over 30 years, you pay $247,218.25 in interest payments. This is why many borrowers consider a shorter term loan, such as a 15-year fixed. Assuming a 15-year fixed loan at the same interest rate of 4.5% and $300,000 loan amount, the amount of interest paid is $113,096.33, less than ½ of the interest on a 30-year fixed loan.

There are loans that are not amortized. Interest-only loans require a minimum interest payment, but a payment over the interest goes directly to principal and would lower the interest-only payment. There is another product that is a line of credit that can be used as a checking account. Every payment to the line goes to principal first.

If you have a question about your loan, or a non-amortizing loan, ask us and we can help.

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