Every mortgage has a certain structure that, when explained in legal language, can be difficult to understand. The terms used to describe components – like “the index” and “the margin” – can throw many first-time homeowners for a loop. But understanding your mortgage before signing it is crucial for keeping your payments manageable and your investment secure. Here’s a simplified description of how mortgages are built:
- The Principal. The principal refers to the total amount of money that you’ve borrowed. For instance, if you borrowed $150,000 to buy a home, then your mortgage principal is $150,000.
- The Interest Rate. The interest rate of a mortgage refers to the amount of interest you owe every payment. This number is typically formulated by taking into account several variables, including your credit history, the size of your down payment and the prime rate index issued by the Federal Reserve. After all these calculations, you’ll typically end up with something like a 6.02% interest rate, which means that after all is said and done you’ll have paid 106.2% of your loan amount back to your lender. Because one percentage point can mean thousands of dollars when you consider the size of a home loan, you should always aim for the lowest interest rate possible.
- The Term. The period of time over which you’re to pay off your loan is referred to as the mortgage’s term. Most mortgages run on either 15- or 30-year terms that require monthly payments. Since the 15-year option is less risky for your lender, it tends to carry a lower interest rate.
- Taxes and Insurance. In addition to your regular mortgage payment, you’ll also have to pay a fee for taxes and insurance each month. Every local government levies a tax on all mortgagees living in the county, and in addition to that, nearly all lenders require their mortgagees to have home insurance so that their real estate investment is protected.
A mortgage can be a confusing loan to understand, but it doesn’t have to be. If you remember to aim for the lowest interest rate and the shortest term that you can manage, then paying off your mortgage will be easy and manageable.
