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Robert  Guth

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Understanding your monthly payment


When it comes to mortgages, many people get confused about their payments. How are they calculated? What will be the amount paid each month?

A loan is “amortized,” which means you will be paying it off over time, usually with monthly payments. These payments are set up to pay both interest and principal. If you have a fixed-rate mortgage, your payments will stay the same over the life of the loan.

The words “amortize” and “mortgage” have the same origin. They both come from the Latin word “mort,” meaning death. When you amortize your loan, you are in a sense killing off the debt. This is different from a loan that goes on indefinitely. A mortgage has a set term, a length of time you are given to pay it off completely.

The formula for calculating the payment is not simple. In order to predict your payments for a given interest rate, you need to plug the numbers into a mortgage calculator.


Analyzing the cost of your loan


Let’s look at an example loan amount and analyze the cost.

For a loan of $100,000, with a fixed interest rate of 6% for a period of 30 years, your monthly payment will be about $600. Most of this will go toward the interest in the early part of the loan.

With your first $600 payment, $500 would go toward interest and $100 toward principal. This makes sense if you look at these examples:

$100,000, your loan amount, x 6%, your interest rate, = $6000
$6000 / 12 months = $500, the interest for the first month

So, by the second month you owe $99,900. After plugging the numbers into a mortgage calculator you will see that by the end of the first year you will owe $98,772, meaning you would have only paid $1,228 of the principal of your loan.

Some people are shocked to realize that, because they spent $7,200 in mortgages payments for the first year. However it does make sense. The lender needs to make sure to continue to get the interest on the principal owed while also helping you to pay down the loan over 30 years.

As the years roll by, since your payment stays fixed, more and more of the payment will go to actually paying down the loan principal. That is because with each passing payment there is less interest to pay. With each payment you have paid off more of the principal.

After around 18 years your payment will be evenly split between principal and interest, with about $300 going to each. Each year after that, your payment will go more toward paying principal.

If you simply paid interest only, that would be $500 and the loan would never be paid off. So if you have an “interest only” option with your loan, the lender will not allow this to continue for too many years. Usually the limit is five to 10 years. When that period is up, your payments will increase so you can pay off your loan in 30 years.

When you refinance a loan, you start over. Your 30-year term begins again and you start again at year one, paying mostly interest with each payment.

You will notice that your first payment is due about a month after closing. That is because the interest must accrue. You pay interest at the end of a time period, rather than prepay it.


Paying for hazard insurance


Hazard insurance, on the other hand, must be paid ahead of time. Lenders need this in place in order to loan you the money. They need to be sure the property is covered in case of a disaster. You will pay for the first year of insurance at closing.

You are often given a choice as to how you want to handle the second year of insurance and the first year of property taxes. Many lenders ask you to “escrow,” putting money aside into a separate account with them for property taxes and insurance each month, starting with the first payment. That way you avoid getting hit with a large payment at the end of each year. In other cases you are left to deal with those additional payments yourself.

Another cost, private mortgage insurance or PMI, may be required by a lender if your loan-to-value ratio, the amount of the loan divided by the value of the home, is too high. This protects the lender, not the homeowner, in case you default on the loan. Your monthly payment may also include additional amounts added to pay off escrow accounts for taxes and insurance or to pay off PMI.

There are different kinds of loans. You need to understand yours fully and know how the differences can affect your monthly payment.

If you have an adjustable-rate mortgage, your payment will vary according to your agreement. Typically, there are adjustment caps so that you can’t suddenly have a payment soar. Also, there are usually periods where your payment can adjust, so you can plan for and predict the changes. With an adjustable-rate mortgage your payment can go up or down.

Most mortgages simply have payments designed to pay off your mortgage in 30 years. Once you understand how an amortization schedule works and what the various charges signify, your payment is not difficult to understand.


Understanding your credit


Thinking about buying a house? Then think about your credit history...the folks who lend money do!

How well you have handled your credit obligations in the past is of utmost importance to lenders today. The good news is that this information, for the most part, is available to you.

Your credit history is maintained by three different private companies called credit reporting agencies: Equifax, TransUnion and Experian. You can order your report by phone and charge it to your major credit card if you like. It usually takes about a week to arrive. Or you can order your report online and view it within seconds.

It's a good idea to get a copy of all three reports, because if an error exists on even one of the reports, it may negatively affect your chances of getting the loan you want. Your credit report lists all the consumer credit that has been extended to you over the past seven years. It will show what your highest balance has been and what your current balance was on the date last reported by the creditor. It will also show how many payments you made on time and how many late payments were late. Late payments are grouped into categories showing how late you were. For example, if your credit card payment was over 30 days late one time, it might not be considered too serious. But if payments were over 60 days late four times, over 120 days late two times and over 180 days late one time, you have had a serious problem. That problem is going to impact your ability to borrow money.

It just makes sense to find out about your credit and correct any errors now. Regardless of how many credit problems you have had in the past, there are two good points to remember.

First, negative credit information can be reported in your credit file for only seven years. After that, it drops out and cannot even be considered. The one exception is bankruptcy, which can be reported for 10 years. But after that you start with essentially a clean slate.

Second, lenders are much more concerned about how you have handled your credit recently than with what happened several years ago. Even if you have had a bankruptcy, if you have kept your nose clean and paid your bills on time since then, it is possible you could qualify for a loan after as little as two or three years.

One of the best developments in the world of lending has been risk-based pricing. That's a five dollar term for the ability of lenders to offer higher priced loans to borrowers based on their demonstrated ability to repay. In other words, even if you have slightly fractured credit, you can still likely get a loan. It just may cost you a little more.


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