Have you ever wondered how interest on a mortgage works? Many do, but not everyone asks, for fear of looking unintelligent. Today, we’ll answer the question, “how does interest on a mortgage work?” so you won’t even need to ask. And we’ll also take a look at a few other interest-related FAQs. Let’s get started.
Why do I pay interest?
Basically, when you get a mortgage, the lender (a mortgage company) is giving you their money. While it’s true that you will pay them back, they collect interest on the amount you owe them, so that they’re making money in the process. You’re paying the lender not only for the privilege of using their money but also for the risk they’re taking on you.
How does interest on a mortgage work?
Now we’ll take a look at the question, “how does interest on a mortgage work?” Because every loan is different, there isn’t always a specific percentage for interest. Each interest rate varies for each loan. Either way, for your loan, there will be a percentage that your lender and/or you decide on. Every month, you’ll be required to pay back a part of the amount you borrowed. The amount you borrowed is called the principal amount.
Generally, the amount you borrowed will be what decides how much interest you’ll pay. Which, in turn, will lend a hand in showing how much you’ll pay each month. Furthermore, the length of your loan will also determine how much you pay each month.
You and your lender will decide on the length on your loan. The longest loan available in the United States is 50 years. Generally, the longer you stretch out your loan, the less you’ll have to pay each month.
Let’s take a quick overview of what we’ve learned. Generally, the amount you pay in interest depends on three things:
- Your interest rate
- The amount of your loan
- The length of your loan
Now, let’s take a look at a few interest-related, frequently asked questions.
What is the difference between APR and interest rate?
These are slightly tricky subjects, and often confusing. We’re going to look at the definition that The Consumer Financial Protection Bureau gives to try to understand better.
They say that “the interest rate is the cost you will pay each year to borrow the money, expressed as a percentage rate. It does not reflect fees or any other charges you may have to pay for the loan. An annual percentage rate (APR) is a broader measure of the cost to you of borrowing money, also expressed as a percentage rate. In general, the APR reflects not only the interest rate but also any points, mortgage broker fees, and other charges that you pay to get the loan.”
Therefore, the interest rate and APR are not the same things, even though some people confuse them as such.
Can my interest rate be locked?
Generally, locking in an interest rate can be an important step when getting a loan. But many have never heard of an interest rate lock and even fewer know what it is. An interest rate lock is exactly what it sounds like.
It means that once you have secured how much you’re going to pay for interest, you “lock” it. Therefore, your interest rate stays the same the entire time you’re paying off your mortgage. It can not be raised or lowered.
Why are most of my first payments interest payments?
Generally, when it comes to something as confusing as mortgages, some people don’t even consider what they’re paying money for. Just so long as they pay it and don’t get in trouble, they’re happy. But for those of you who do notice what you’re making a payment on, you’re probably wondering why many times, your first payments are interest payments.
Obviously, when you first get a loan, the principal amount is the highest it will ever be. Therefore, your interest is being added to a larger amount. Every month, as you pay back your lender, the principal amount gets lower and lower. Which means that you’ll be paying interest on a number that gets smaller and smaller as time goes on.
Furthermore, you’re going to be paying a disproportionate amount of interest in the first few years because the lender wants to make sure they get their money’s worth out of your mortgage. If they lend you money to buy a house, and in the next year, you resell the house, they’re not going to get as much interest as they could have.
Get a mortgage that works for you!
Now that we’ve learned a little more about the aforementioned question, “how does interest on a mortgage work?” it’s time to get your process started! Don’t be daunted by the large amounts of information that’s out there. Mortgage One Brighton will help you every step of the way. For more, take a look at our quick start guide!