Most borrowers pay off their mortgage with monthly payments. Their mortgage payments include these two portions:

Interest: the rate the borrower pays the lender in exchange for the money lent

Principal: the remaining amount of the monthly payment goes towards the borrower’s remaining principal

For each monthly payment, the bank calculates the interest a borrower owes on their remaining principal.

A Little Shorthand Help

For these examples, we will be using these abbreviations to simplify things:

P1 = portion of first payment that goes towards principal

I1 = portion of first payment going towards interest

P2 = portion of second payment that goes towards principal

I2 = portion of second payment going towards interest

So, P represents the portion going towards principal, I represents the portion going towards interest, and the numbers represent which monthly payment we are referring to.

Mortgage Payment Breakdown

If interest is calculated by multiplying a borrower’s interest rate by their remaining principal (and then dividing that answer by 12), then you might be thinking…Wow, so the interest portion of a mortgage payment must be higher earlier in the loan.

Yes, Anthony, you are correct. The greater the remaining principal, the greater amount of interest the borrower owes.

So, if Interest = Interest Rate x Principal, we can then deduce that a lower principal will mean lower interest payments.

Interest rate x Principal = Interest

Lesson: If your client can make larger mortgage payments at first, they will pay more towards their principal and save money long-term that otherwise would have been spent on interest. Paying money upfront to reduce a loan’s interest rate and monthly payments is also called a buydown.

Diminishing Principal

All good things must come to an end, Anthony. So it is with life, and so it is with this chapter. But before you go, let’s review some of the important terms, concepts, and principles you’ve learned along the way.

Key Terms

Here are the key terms you learned in this chapter:

origination fee

fees charged by the lender to pay for the loan origination; aka origination points

points

fees that the borrower pays when they take out a loan; two kinds are origination points and discount points

buydown

the paying of money upfront to reduce a loan’s interest rate and monthly payments

Key Concepts & Principles

Here are the concepts and principles you’ll want to master from this chapter.

Mortgage Payment Breakdown

Most borrowers pay off their mortgage with monthly payments. Their mortgage payments include these two portions:

Interest: the rate the borrower pays the lender in exchange for the money lent

Principal: the remaining amount of the monthly payment goes towards the borrower’s remaining principal

Since Interest = Interest Rate x Principal, we can then deduce that a lower principal will mean lower interest payments. Therefore, the greater the remaining principal, the greater amount of interest the borrower owes.

Solving for Total Interest Paid

To find the total cost of a mortgage, use the following formula:

Monthly payment x Number of payments = Total loan cost

Remember that 15-year loans have 180 monthly payments and 30-year loans have 360 monthly payments. Since 30-year loans require more payments, they are usually more expensive in the long run.

Point Math

Origination points are fees charged by the lender to pay for the loan origination. Discount points are paid by the borrower to lower the interest rate.

But whether they are origination or discount, they cost the same amount.

1 point = 1% of the loan principal

To find the cost of points, remember this formula:

Loan points x Loan principal = Total cost of points

Chapter Summary