Understanding Your Mortgage Payment

Understanding Your Mortgage Payment

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    Published 17/11/2020 12:11 EST
    Updated 24/11/2020 12:11 EST

    Your mortgage payment consists of two main components: 1) Principal and 2) Interest. Together, they make up the money you’re obligated to hand over to your lender every month to pay off the amount you borrowed to buy your home. 

    In the early stage of your mortgage, your lender will apply a larger portion of the payment towards the interest, with the remainder going towards the principal. Over time, however, an increased portion will be applied towards the principal until it’s paid off in full. Lenders use a standard formula to calculate these figures to ensure the right amount is paid in both interest and principal. 

    Key Takeaways
    • Your monthly mortgage payments are made up of interest and principal. In the early stage of your mortgage, a larger portion of the payment is put towards interest. But, over time, an increased portion will be applied towards the principal
    • When finalizing your mortgage, you’ll need to decide how often you want to make your payments, which impacts how quickly you become mortgage-free
    • When calculating the true cost of homeownership, there are many important considerations in addition to your mortgage payment that should also be included in your homeownership budget

    Important

    In addition to the amount you borrow for your actual mortgage, each mortgage payment may also include mortgage default insurance (when your down payment is less than 20%) and property taxes

    Mortgage payment options

    Throughout the life of your mortgage, you may have the option to put down extra money in order to pay down the balance faster. This is known as a pre-payment.

    The main difference between an open and closed mortgage is the amount of flexibility you have with your payments. An open mortgage allows the most flexibility, typically without penalty. At any time, you can make extra payments, a lump sum payment or even pay off your mortgage completely before the end of the term. It’s important to note that, as a tradeoff for added flexibility, the interest rate on an open mortgage is generally higher than on a closed mortgage. 

    If you have a closed mortgage, you may have the option of putting extra money towards the mortgage, but you’ll be limited in the amount. This is known as a pre-payment privilege and the rules vary by lender. Some lenders don’t allow for any pre-payment.

    👆 Tip

    Unless you have an open mortgage, you can often only pre-pay a certain amount of money each year towards your mortgage without facing a penalty. Be sure to know your limits as they vary by lender

    Mortgage payment frequency

    When finalizing your mortgage, you’ll need to decide how often you want to make your payments. Determining your payment frequency has an impact on how fast (or slow) you reduce the principal, the amount of interest you pay, and when your mortgage will be paid off. Choosing your payment frequency will depend on your other financial obligations as well as your comfort level. And while there are many advantages to committing to a more frequent payment, you should select the frequency best suited to your financial situation. 

    When you increase or accelerate, the payment frequency, you reduce the principal faster and, therefore, pay less interest. Your payment frequency is determined when your mortgage is first arranged but you may be able to change it at a later date, usually without having to pay a fee.

    Here are the most common payment frequency options:

    • Monthly – 12 payments/year. Payments are made once a month, usually on a day that you chose
    • Semi-Monthly – 24 payments/year. Your monthly mortgage payment is divided into two monthly payments
    • Accelerated Bi-Weekly – 26 payments/year. Payments are made every two weeks. Many people select this option based on the convenience of having payments coincide with employer pay periods
    • Accelerated Weekly 52 payments/year. Payments are made once a week

    Either accelerated bi-weekly payments or accelerated weekly payments are effective options for paying down your mortgage faster. 

    👆 Tip

    When you accelerate your payment frequency, you end up making approximately one extra payment a year, which could end up saving you thousands in interest over the life of the mortgage

    Amortization

    An amortization period refers to the length of time it takes to pay off your mortgage in full. Typically, amortization periods are 15, 20 or 25 years. Many people opt for a longer amortization as it represents lower monthly payments. But because it also represents a longer period of time that you have a mortgage, you’ll pay more in interest. Conversely, the shorter the amortization period, the less you pay in interest, but your monthly payments will be higher. 

    Determining your payment

    In order to determine your mortgage payment, you need to take into account the following:

    • Amount – this is represented by the price of your home, less your down payment (plus mortgage default insurance, if applicable). The more you borrow, the higher your mortgage payment
    • Amortization – if you have a longer amortization period, you’ll have lower monthly payments, but you’ll pay more interest over the life of the mortgage. A shorter amortization means paying off the mortgage faster, but your payments will be higher
    • Frequency –how often you make your payments will affect the amount of each payment. Ex: monthly payment is a higher dollar amount than a weekly payment. Also, when you make payments more frequently, your interest expense is reduced as the balance is lower at each moment the interest compounds.
    • Rate – this is the interest charged on your mortgage. The higher the interest rate, the larger your mortgage payment. You can select a fixed-rate mortgage so that your payment remains the same each month, or a variable-rate mortgage where your payment fluctuates with the rise and fall of rates

    Use nesto’s online Mortgage Payment Calculator to help assess the amount of your payments using different options/scenarios. 

    Additional monthly costs

    When calculating the true cost of homeownership, there are many important considerations to be aware of in addition to your mortgage payment (See: Closing Costs: What are they and How Much Will You Pay?)

    Here’s a list of some of the most common expenses you’ll incur that should also be included in your homeownership budget: 

    • Property taxes (See: Property Taxes)
    • Home insurance (eg, protection against theft, water damage, fire)
    • Mortgage default insurance (if your down payment is less than 20% and not incorporated into your mortgage) (See: What is Mortgage Loan Insurance?)
    • Utilities (heating, hydro, gas, water)
    • Maintenance fees and general upkeep ( eg, landscaping, snow removal, furnace and air conditioning, roof repairs)
    • Cable, Phone & Internet
    • Condo or maintenance fees (if applicable)
    • Security system (if you have one)
    •  

    For a very small percentage of people, becoming a homeowner means buying their home outright. For the rest of us, homeownership requires a mortgage, and with it, mortgage payments. Remember that, with each payment you make, you’re building equity in your home and becoming one step closer to becoming mortgage-free. 

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    Read all the articles in this guide

    Mortgage Payment Options

    Depending on your situation, what type of mortgage payment structure should you opt for?

    What is an Amortization Period?

    The most common amortization is 25 years, unless you decide to tap into your home equity and pay your mortgage faster!

    Monthly Carrying Costs When Buying a Home

    The cost of homeownership involves so much more than your monthly mortgage payment. Here are some of the "other costs" to consider into your budget.

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