The calculation of interests on a home mortgage depends on several factors, including the loan amount, interest rate, and loan term. These factors not withstanding are subject to adjustments.
From the interest rate your lender sets to the loan term you sign up for, there are several factors that affect how much interest you pay and you can save thousands by taking advantage of those terms.
What Factors Affect The Amount of Interests You Pay?
The following factors will affect the amount of your interest payments
- The mortgage interest rate: This is the rate at which the bank charges you interest on the loan. Even a small difference in the interest rate can add up to thousands over the life of the loan.
- The federal funds rate: The interest rate on your loan is loosely tied to the federal funds rate set by the Federal Reserve, which dictates the rate at which banks lend money to each other overnight. If you have a variable interest rate, paying attention to the federal funds rate can help you predict what your interest rate will do.
- The amount you borrow. The more you borrow from your bank, the more interest you’ll need to repay. For example, 5% of $1 million will always be a larger amount than 5% of $500,000.
- The outstanding loan amount. As you gradually pay off the money you borrow, you will be paying interest on a smaller loan amount and your interest payments will slowly reduce.
- The loan term. The time you take to pay off your loan will affect the amount of interest you pay — paying your loan off over a shorter period of time will minimize your interest.
Principal and interest vs. interest-only
Another factor that can affect your monthly mortgage payment: whether you’re making principal and interest or interest-only payments.
Principal and interest payments are the most common way to pay off a home loan.
This automatically means that one portion of your monthly payment goes towards paying off the amount you borrow and another portion goes to paying off the interest you owe.
However, some loans are designed to allow you to make interest-only payments for a certain period, for example if you’re building a new home or if you’re a property investor with an investment mortgage.
This allows you to reduce your monthly payment amount. You can also read and know What’s Interest-Only Mortgage: How It Works and it’s Pros and Cons?
How to Save Interests on Your Mortgage
Having understood more about how interests are calculated, let me show you a few ways you can actually pay less of it.
- Get the best rate. Shopping around for a better interest rate can save you thousands of dollars. If you already own a home, you may want to consider refinancing with your current lender or switching to a new lender.
- Make frequent payments. there are a little over four weeks in a month, if you make biweekly instead of monthly mortgage repayments, you will be making two extra payments a year.
- Make extra payments. The quicker you pay down your loan amount, the less interest you’ll need to pay on your smaller outstanding loan amount. If you have a variable interest rate, you can save even more by making extra payments when interest rates are low.
- Choose a shorter loan term. The longer you take to pay off your loan, the more interest you will have to pay. Remember, banks calculate interest on your loan amount everyday, so choosing a 25-year loan term instead of 30 years can make a big difference.
Why do lenders charge interest on a mortgage?
The money you borrow with a mortgage basically comes from other people and organizations who deposited it with your lender. It is not your lender’s money, it belongs to others. Your lender has to pay them interest for the use of the money.
A lender, such as a bank, needs to pay wages, shareholders and other expenses. They also need to make a profit, just like any other business. To do this, your lender charges you interests on the money you borrow through your mortgage.
However, they only keep a small part of it. Most of the interest you pay covers the interest the lender pays to the people whose money you have borrowed.
To ensure the lender makes enough to stay in business, mortgage interest rates are always higher than savings and investment interest rates at any time.
It is important to note that as while making your monthly payments, the loan balance decreases, which affects the amount of interest paid each month.
Over time, the interest portion decreases, and the principal portion increases, gradually reducing the loan balance.
This will make it more easy and convenient for you to pay off what you owe.
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