SL 1: Review of Mortgage Loan Components
understanding how mortgage work
There are three parts to a mortgage:
- principal:
the original amount that you borrow with an obligation to repay the amount over a set term.
- interest:
a percentage amount that you agree to pay the lender for use of the principal amount until the full amount is repaid.
- term:
the length of time (generally in months) to repay the principle.
Example: the lender gives a home buyer $100,000 to buy a home. The buyer agrees to pay 6% annually on the loan balance for 30 years (term) until the entire amount has been repaid.
If the buyer pays interest-only payments, s/he will pay the lender $6,000 each year for use of the loan:
(calculated as: $100,000 X 6% = $6,000)
However, the buyer needs to pay back the loan over a period of time (term),
So s/he will pay an additional amount over the required interest payment to reduce the principal amount to zero.
There is a mathematical formula that constructs an amortization schedule that shows what monthly dollar amount the buyer must pay in order to reduce the loan to zero over a certain period of time; i.e., 30 years.
All amortization schedules use a term: the most common term for home mortgages is 30 years (360 months). But other mortgage terms may include 15, 20 and 25 years.
There are even 40- and 50-year mortgage terms in some markets.
Download this spreadsheet to run your own numbers.
Scroll down the spreadsheet to see the accumulated interest paid over the life of your loan.