What is Principal, Interest, Term and Amortization

While these factors are basic to a mortgage loan, it is equally true that the principal amount, interest rate, term and modernization is common to all kind of loans. It does not matter what you are buying from the money that you borrow, these terms will apply and will hold you in good stead if you understand them. Let us speak about them one by one.

Principal

The principal of the loan is the amount that you have originally borrowed. If you borrowed $200,000 to purchase a home, then $200,000 is the principal amount.

Interest

Interest is what the mortgage lender or any other kind of credit lender earns on the principal amount that you borrow. Taking the previous example of a mortgage of $200,000 from a lender, the lender will charge a certain rate of interest on this amount. This is what he will earn on the money he has lent you. The interest rate on different loans differ. While a mortgage loan usually has the lowest of interest other kind of loans such as credit cards may have interest rate as high as 24%.

Consumer interest for outstanding balances such as credit card debt and a car loan is not deductible on your federal income. Interest paid on a home loan can be used as deductions from your state and federal income tax. This is one of the many advantages of taking a mortgage loan.

Term

The ‘Term’ of the loan is the duration in which you are supposed to pay back the principal plus interest to the lender. This is the time given to you by the creditor to repay the money that you have borrowed. Smaller loans usually have a smaller term whereas larger loans have a longer term. You typically get more time to pay back larger loans in order to keep the monthly payments low. For example you would spend $734 a month to repay $100,000 loan with an 8 percent interest rate on the 30 year mortgage term. The same mortgage would cost you $956 a month with a 15 year term. Even though the 15 year loans payment is $222 higher you’d pay far less interest on it over the life of the loan.

At 8% you are paying $72,080 in interest over 15 years whereas for 30 years you’ll be paying $164,240 as interest. Don’t get fooled by a low monthly payment for long-term mortgage. It will be more costly in the long run as compared to a mortgage with a shorter term. The reason why people choose a longer term over a shorter term is to reduce the monthly payments and to make it the size that they can afford to pay comfortably every month. Apart from that, the quicker that you can pay off the loan the more money you save.

Amortization

The fully amortized monthly payment means that if all other factors remain same such as the interest rate and the term, your loan will be fully repaid by the time you’ve made your final loan payment according to the term of the mortgage.

Typically speaking, each monthly mortgage payment that you make fully amortizes what you owe on the loan. Amortization means making periodic installment payments on a loan amount which consist of principal and interest.

Usually the amortization schedule of your mortgage or any other kind of loan is worked out in such a way by the lender that during the initial years of the loan, the installment payment goes mostly towards paying off the interest and very little towards reducing the principal balance owed on the loan. This ratio decreases with time. So in other words, the lender makes sure that he takes his profit on the loan from you as quickly as possible.

Mortgage Interest Rate

The interest-rate of a mortgage is probably the top crucial factor in any mortgage related decision.  Since a mortgage loan is for our large amount of loans and continues over a long tenure of as long as 30 years, even a small change in your interest-rate can make a difference of thousands of dollars over the years.  During the initial phase of a mortgage a major part of repayment course towards paying off the interest while only a small portion of it is allocated to paying off the actual principal amount that you borrowed.  So having a low interest-rate means that you are going to pay less on the interest and more on the principal amount.  Not only do you save money in the long run but also gets to pay off your mortgage loan faster.

In order to get the best interest-rate on a mortgage you need to do your research and shop around.  In case you decided to work with a particular lender for personal reasons you should be ready to negotiate.  All mortgage lenders are in it for profit.  They are not doing you any favour by giving you a mortgage loan but stands to make money from it.

The commonest aspects of negotiating the interest-rate with a mortgage lender is whether to choose a fixed-rate interest or a variable-rate interest on the mortgage.  Lenders may typically try and inclining towards a fixed rate mortgage with a long term.  Mortgage lenders try and make de which will be the most profitable to them in the long run same as you will try and make a deal that is the most beneficial to you.  If you compare the difference between a fixed-rate mortgage and a variable rate mortgage you would realise that you will probably end up paying more for a fixed-rate mortgage that is locked in for a period of five years.  This is because the lender would probably charge you are a higher rate of interest than he would on variable rate mortgage.  This is done by the lender to ensure himself against any fluctuations in the future and to guarantee you one particular rate that you want.
However if you’re ready to accept a bit of a risk on your end you just might be better off with either a shorter term or a variable-rate mortgage.  To begin with a variable-rate mortgage allows you to have a much lower rate of interest to begin with.  In case you are worried about the future fluctuations in the market you should check with the lender whether he provides you with the ability to change over to a fixed-rate when you choose to.  So while you start of whether a low rate of interest you can change to fixed-rate mortgage if you anticipate unfavourable changes in the market.
You are liable to save money with a variable rate type of mortgage as long as the lender does not charge you are penalty fee for switching from variable to a fixed-rate.

A shorter term also allows you the same kind of freedom.  A shorter term, such as six months allows you to change to the lower rate of interest if they happen to drop in the future. It allows the opportunity for renegotiation and reassessment of the terms and conditions of your mortgage if required.  If you find a lower rate in the future you can always increase the term to a few years. Being locked in for a longer term will prevent you from doing so.

What Is An Interest Only Mortgage

This is a rather unusual kind of mortgage loan.  An interest only mortgage means that the consumer takes the loan to purchase a property and then only pays interest due on that loan every month.  No part of the payment goes towards paying off the original principle amounts that is owed on the mortgage loan. This means that your debt will never be paid off.

There are very few situations and circumstances when taking a mortgage like this actually makes sense.  Interest only mortgage will no doubt reduce your monthly payments to a great extent.  Hence, it can be used to relieve the financial burden if you happen to be going through a rough financial time. 

The commonest reason and the one that makes the best sense is using it for an investment property. When you are buying simply because the real estate market is in a boom and you hope to build some great equity in the property shortly.

You can use the enhanced cost price of the property after the few years to pay off the mortgage loan and make a profit.  An interest only mortgage can also help you save on taxes if you are able to write off the interest as a part of a business venture.

Since an interest only mortgage is a tricky venture it is advisable to speak with a financial professional.

How to Get A Low Interest Rate Mortgage

Interest rate is the single most prominent factor both on the minds of the borrower and the lender. The lender would like to charge as much as he can get away with and the borrower wants to pay as less as possible. 

Well, its possible to get great deals on your home loans and have the lender settle for a low interest rate. Here’s how its done.

  1. Shop around for the best mortgage loan.
  2. Be ready to negotiate.
  3. Improve your credit rating.
  4. Come prepared with information to convince the lender of your credit worthiness i.e. proof of income, job stability, financial resources etc.

Shopping around and looking at the deals that various mortgage lenders are offering may give you a better idea of the interest rate that you can bargain with the mortgage lender that you want to work with.

For example if you want to take a home loan from the bank that you personally deal with but are not happy with the interest rate, you can easily cite the example of another financial institutions offering better terms. 

The better informed you are about the various types of mortgage options available to you from different lenders the better position you will be in to bargain for the deal that you wish to strike.

Negotiate fees and charges. You should be in a strong position to ask for better terms. This can happen when you have strong financial resources and a great credit rating. If you are high in demand as a borrower, your lenders will be more flexible in order to get your business.

Find online mortgage lenders. These companies have a low over-head since their operational costs are low. They have fewer employees to handle the online business and do not maintain as many physical offices. Therefore, they are able to pass on these savings to the borrower by offering lower interest rate on the home loan.

Use mortgage broker. These brokers are often aware of smaller lending institutions that offer competitive rates than bigger and more popular banks and finance companies. Remember that the broker could be working on a commission basis with the lending company. It is important to do your own research and not to go only by the word of the mortgage broker.

Negotiate Extra Fees. There are several charges that are not mandated by law. Sometimes when a lender offers you low interest, he adds on these ‘junk charges’. Question every single fee and negotiate the useless ones.

Why A Small Change In Interest Rate Makes A Big Difference To Mortgage Payments

A small difference in the interest rate of a home loan can mean thousands of dollars over the tenure of the mortgage.

Mortgage loans are typically low interest rate loans. This is of course relatively speaking when you compare the mortgage loan to other kinds of loans such as personal loan, credit card, automobile loan etc. When you decide to apply for a mortgage loan the primary factor that you consider is perhaps the interest rate.

While the interest rates being offered on a mortgage loan by various lenders may seem to be more or less the same with small difference, you should be aware of the fact that even a small difference in the interest rate can make a difference of a large sum of money.

effect of changes in mortgage interest rates

A mortgage loan is typically a loan for a large amount of money, the repayment for which is extended over a long period of time usually ranging from 15 to 30 years. A simple calculation will tell you how even the difference of .5% on the mortgage loan will save you or cost you thousands of dollars more.

Let’s say you take a mortgage loan for $250,000. One lender charges you an interest rate of 7% while another charges you a rate of 6.0%.

For the same mortgage loan you will have to pay a total amount of $530,082 approximately over a tenure of 25 years for a 7% home loans, as compared to approximately $483,225 for interest rate of 6%. This is a difference of more than $48,000.

It is not uncommon to find the difference of one per cent or more in the interest rates offered by various lenders. A lot of the variance depends on factors like the lenders underwriting guidelines for mortgage loan. For example one lender may require a higher credit score than the other. Your personal relationship with the bank of the lender also counts towards you getting a better deal. We shall speak more about how to choose the right mortgage loan in later columns.

The bottom line for now is that before you choose a mortgage you should look around extensively in order to find the mortgage deal that is most profitable for you.