Complete Guide to Mortgages
How does a mortgage work?
A mortgage is a long-term loan used to purchase real estate. The property serves as collateral for the loan: if you stop paying, the bank can foreclose on the property. Mortgages typically have terms of 15 to 30 years with fixed or adjustable interest rates.
Your monthly payment consists of four main components, known as PITI: Principal, Interest, Taxes, and Insurance.
The mortgage payment formula
Payment = P x [r(1+r)^n] / [(1+r)^n - 1]
Where:
- P = Loan amount (home price - down payment)
- r = Monthly interest rate (annual rate / 12 / 100)
- n = Total number of payments (years x 12)
Monthly property taxes, homeowner's insurance, and PMI (if applicable) are added to this base payment.
Practical example
For a $250,000 home with $50,000 down payment (20%) at 6.5% annual for 30 years:
- Loan amount: $200,000
- Principal + Interest: $1,264.14/month
- Taxes (1.2%): $250.00/month
- Insurance: $100.00/month
- Total monthly: ~$1,614.14
What is a down payment?
The down payment is the percentage of the price you pay upfront at purchase. It's crucial because:
- 20% or more: Avoid PMI, get better rates
- 10-19%: Pay PMI but with reasonable payments
- 3-9%: Higher payments and mandatory PMI
A 20% down payment can save you thousands in PMI. For example, on a $200,000 loan, PMI can cost $100-$200 monthly until you reach 20% equity.
What is PMI?
PMI (Private Mortgage Insurance) is insurance that protects the lender when the down payment is less than 20%. It does not protect you as the buyer. It's automatically removed when you reach 80% loan-to-value ratio (or 20% equity).
15-year vs 30-year mortgage
| Feature | 15 years | 30 years | |---|---|---| | Monthly payment | Higher | Lower | | Interest rate | Generally lower | Generally higher | | Total interest | Much less | Much more | | Flexibility | Less | More |
For a $200,000 loan at 6.5%:
- 15 years: $1,742/month - Total interest: $113,560
- 30 years: $1,264/month - Total interest: $255,089
Frequently asked questions
The payment is calculated using the PMT formula considering the loan amount, interest rate, and term. Property taxes, homeowner's insurance, and PMI (if the down payment is less than 20%) are added on top.
PMI is private mortgage insurance required when the down payment is less than 20%. To avoid it, you can make a 20% or larger down payment, or wait until you've built enough equity to request its removal.
It depends on your financial situation. A 15-year mortgage has higher payments but you pay much less in total interest. A 30-year mortgage offers more comfortable payments but the total cost is significantly higher.
The main factors are your credit score, down payment amount, property type, loan term, rate type (fixed or adjustable), and market conditions.
Generally yes. Extra principal payments reduce the outstanding balance, which decreases future interest and can significantly shorten your loan term. Check that your mortgage doesn't have prepayment penalties.
A fixed rate stays the same throughout the life of the loan, providing predictability. An adjustable rate can change periodically based on market indices, usually starting lower but with the risk of increases.
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