Paying Off Your Mortgage
You’ve done it! You’ve signed the papers, transferred the ownership, and now you’ve moved into your new house. You think that now you can sit back and relax, meet your new neighbors, and make your monthly mortgage payments, accruing equity along the way.
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However, at the end of the year, you receive your annual mortgage statement from your lender. You open your statement, anxious to discover how much equity you’ve been able to amass. When you take a closer look, the equity you have accrued feels depressingly small. But, you haven’t missed a mortgage payment.
What’s going on?
Interest, then Principal
When you sign-up for a fixed-rate mortgage, your lender creates a payment plan for you to return the loan.
To give you certainty, your mortgage plan will consist of monthly payments that remain the same over the lifetime of the loan. This means that at the beginning of your loan, most of your monthly payments will be going towards your interest obligations.
This concept is known as amortization. You can understand this dynamic by looking at the amortization tab on the TipRanks’ mortgage calculator. Experimenting with this tool can show you how the different loan components impact the amortization schedule, along with the overall cost of the loan.
Conversely, if you were to only pay interest on the outstanding principal, the loan would vary greatly over time. While your monthly payments would eventually decrease, it would also mean that your initial payments would be much steeper.
In other words, amortization is another way of saying that you will be paying off your mortgage loan over time in equal installments. Your principal and interest payments will vary, not your monthly mortgage payment.
Building Equity in Your Home
The consequence of amortization is that your interest payments will far outweigh the principal you are repaying in the early stages of your mortgage.
This is an important concept to understand, especially if you are planning on using your current house to upgrade to nicer environs sooner rather than later. In other words, if sell your house in the early years of your mortgage, you probably will not have accumulated much equity to use towards buying another property.
However, there are a number of ways that you can build equity faster, transferring more and more of the house that you own outright.
(1) Refinancing your loan: If your financial situation changes, you can look to refinance with a shorter-term mortgage. This will allow you to repay your mortgage back faster by increasing your monthly payments, and decreasing the overall cost of the loan.
(2) Improve the value of your home: Renovating your home by building a new kitchen or adding desirable features such as solar panels can increase the value of your property. This can be a win-win situation, as it can make your living situation more comfortable while also raising the prospective price you will be able to charge if and when you decide to sell your home.
(3) Making additional payments: Some mortgage lenders will allow you to make more frequent payments and/or use unexpected windfalls (such as a work bonus, tax refund, or inheritance) to pay off larger chunks of your mortgage. Be aware of prepayment penalties, however, which some lenders charge.
Conclusion: Knowing Where You Stand
Buying a house is usually part of a long-term plan. At the beginning, your mortgage lender will be the principal (pun intended!) owner of your property. Through the concept of amortization, you will pay off your debt via equal installments over time. As you progress with your monthly payments, you will eventually accrue more and more of the equity in your house. There are strategies to build-up equity faster, if this is important to you.
Regardless of your plans and priorities, the amortization tab on the TipRanks’ mortgage calculator can help you understand exactly where you stand in terms of paying off your mortgage interest and principal.
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