A mortgage is amortized. That means that although the monthly payments are equal, the amounts applied to principal and interest change each month.
When you select a mortgage, you will have to decide on an amortization period, or a number of years that you will have to repay the loan. The timeframe you choose will affect your monthly payment amount and the total that you will have to pay in interest.
How the Amortization Period Can Affect Your Costs
If you select a mortgage with a longer term, such as 30 years, you will have lower monthly payments than you would have with a 15-year mortgage. The tradeoff is that you will pay more in interest over the life of a 30-year loan.
Choosing a mortgage with a longer amortization period may mean that you will spend tens of thousands of dollars more in interest. If you select a 15-year loan, you will pay less in interest because of the shorter term. You may also qualify for a lower interest rate.
How Amortization Schedules Work
If you choose a mortgage with a fixed interest rate, your monthly payments will be the same over the entire term. Early in the repayment period, the bulk of each payment will go toward interest charges. The amount of each payment that is applied to the principal will gradually increase, while the sum applied to interest will gradually decrease.
In the early years after you take out a home loan, you will build equity slowly. As you get closer to the end of the repayment period, you will build equity more quickly.
How to Keep Your Costs Down
If you want affordable monthly payments, a mortgage with a longer amortization period may be your best option. If your goal is to spend as little as possible on interest, you can select a mortgage with a shorter amortization period.
If you want to keep your interest charges down but aren’t sure that you will be able to commit to making a large payment every month, taking out a loan with a longer repayment period and making extra payments when you’re able can give you flexibility. You may decide to pay an additional sum each month and instruct the loan servicer to apply it to your principal balance, or you may make one or more extra payments when you receive a bonus, tax refund or gift. If you want to have the option to make extra payments, be sure that your mortgage doesn’t have a prepayment penalty.
Which Type of Mortgage Should You Choose?
Compare a variety of loan options from different lenders. Consider how much your monthly payments would be with each and how much you would pay in interest. Think about your income, job security and other goals, such as saving for retirement and paying off credit cards, to figure out which mortgage is best for you.