Understanding Mortgage Debt

The mortgage history in the United States is littered with booms and busts that have enriched and devastated families and investors alike in the good times and the bad. However, the mortgage (a debt contract) remains the overwhelming form of financing of residential property transactions. 

The process is simple, the granting of funds (by a lender) to purchase a residence with good faith that the borrower (debtor) will repay the loan, with interest, over a specific term (usually in years). 

Understanding mortgage debt helps you make better strategic financial decisions. It can be very informative to look at the structure of home loans, and important, as a mortgage will most likely be the largest debt a consumer will take on in their lifetime.

Mortgage Calculation

The understanding of how mortgages work, the products that are available to you in the mortgage marketplace, and the true cost of these loans will help you make an informed financial decision. It is a good idea to look at the structure of loan products to determine their suitability for you.

The monthly payment is important certainly for considering affordability, but there are other important features of any loan that you should consider. 

Compare the monthly payment obligation for a variety of mortgage products.

Compare the interest rate, length, or term of the mortgage.

Compute and compare how much interest you pay monthly, and over the entire life of the loan.

Add the interest paid over the life of the loan, to the original principal balance to see total repayment.

David’s Tip:

To calculate a mortgage payment, you will need some basic information. Then, you can easily complete the calculation by using this mortgage calculator to run the numbers.

Calculator Inputs

The information you need to calculate your monthly payment are listed below. 

• The loan amount or principal, which is the home purchase price minus the down payment.
• The interest rate (or Note rate) of the proposed loan.
• The number of years or term of the mortgage
• The type of loan product fixed-rate or adjustable
• The purchase price or market value of the home

Mortgage Products

Mortgages where the interest rate remains fixed throughout the entire life (term) of the loan is known as a fixed-rate mortgage. Loans that have periodic adjustments to rate and payment are known as Adjustable Rate Mortgages (ARMS). The repayment, or monthly installments, of fixed-rate mortgages take on 2 basic forms; 

1) Fully Amortizing – meaning that the monthly payment which is the same throughout the term of the mortgage, is comprised of interest and principal payments that, when made on schedule, will pay off the loan in its entirety and the end of the term. 

2) Interest Only – meaning the rate of interest is fixed for a far shorter term, and monthly payments are based on the original loan amount, multiplied by the interest rate, divided by 12 months. This calculation of monthly interest-only payments on the loan is clearly a lower payment for the borrower than fully amortizing mortgage products as there is no reduction of the principal balance.

The interest rate and monthly payments of adjustable-rate mortgages fluctuate periodically and can expose borrowers to higher rates of interest and higher monthly payments in the future. There are both fully amortizing and interest-only adjustable products available in the marketplace.

Fully amortizing loan products are by far the most popular, representing over 75% of all mortgage loans in the USA.

How Much Interest Do You Pay?

Mortgages are Simple Interest loans, meaning that you only pay interest on the declining monthly principal balance. A portion of each monthly payment goes toward interest cost, and the remainder of the payment pays down your principal loan balance. 

An amortization table shows you—month-by-month—exactly what happens with each payment. You can use free online calculators to do the job for you. To lower your monthly payment; 

Borrow less (choose a less expensive home)

Obtain a lower rate of interest.

David’s Tip:

Shorter-term loans like 20-, 15- or 10-year mortgages have lower rates of interest but you will have larger monthly payments as you are repaying the debt faster, lower rates and faster repayment means you will spend less on interest.

Qualification for a mortgage

Lenders will go through a process known as pre-approval to qualify you for mortgage financing, and the process can be quite simple; 

Compute your monthly income; use all borrower’s income, for wage earners use current gross income, for self-employed average the net income for the past 2 years.

Use the mortgage calculator to determine the monthly mortgage payment, and then add the other monthly expenses for the home; property tax, homeowners insurance, and condo dues if applicable.

Divide the complete monthly housing expense, and any other monthly consumer payments, by the computed monthly income; and if you are under 45%, you’re good to go!

David’s Tip:

Once you decide to move forward on house hunting, it’s best to get pre-approved by a lender as most sellers will insist on a letter of pre-approval.