Mortgages in Plain Terms

WWhat the payment is made of

A monthly payment usually bundles four different things. Principal repays the sum borrowed. Interest is the charge for having borrowed it. Property taxes and insurance are frequently collected alongside and held in escrow by the servicer, who pays them when they fall due.

Only the first two are the loan. The other two would be owed whether or not there were a mortgage, which is why comparing loans by total monthly payment can mislead: the escrow portion is the same regardless of lender.

Where the deposit is small, a further charge for mortgage insurance may be included. It protects the lender, not the borrower, against the borrower defaulting, and on many loan types it ends once enough equity has accumulated.

AAmortisation, and why early payments feel wasted

An amortising loan has a level payment that is split between interest and principal in a proportion that changes every month. Interest is charged on the balance outstanding, so at the start, when the balance is at its largest, most of the payment is interest and very little reduces the debt.

As the balance falls, the interest charge falls with it, and because the payment is level, the extra goes to principal. The process accelerates: the second half of a long loan repays vastly more principal per year than the first half, even though the payment never changed.

This is also why an additional payment made early is disproportionately effective. It reduces the balance on which all future interest is calculated, and the saving compounds for the whole remaining term.

TTerm and rate

A longer term lowers the monthly payment and raises the total interest paid, because the balance is outstanding for longer. A shorter term does the reverse. Neither is correct in general; the choice is between monthly affordability and lifetime cost, and it depends on circumstances this page cannot know.

A fixed rate holds the interest rate for the life of the loan, so the payment is predictable and the risk of rate movements sits with the lender. An adjustable rate is fixed for an initial period and then resets periodically against a published index plus a margin, within caps that limit each adjustment and the total. The borrower carries the risk in exchange for a lower initial rate.

The relevant question about an adjustable loan is what happens at the first reset under unfavourable conditions, and whether that outcome is survivable. The initial rate is the least informative figure in the document.

PPoints and the cost of the rate

A point is a fee of one per cent of the loan amount paid at closing to obtain a lower interest rate. It is a trade: cash now against a smaller payment later. Whether it is worthwhile depends entirely on how long the loan is actually kept, and loans are very often not kept for their stated term.

Because fees and rate can be traded against each other, comparing quoted rates alone compares nothing. The comparison has to include what is being paid at closing to achieve each rate.

WWhat underwriting examines

Underwriting is the lender's assessment of two questions: whether the borrower can repay, and whether the security is adequate.

For the first, it examines income and its stability, existing debt service against income, credit history, and the source and seasoning of the deposit. Self-employed and variable income takes longer to document, not because it is worse but because it requires more evidence.

For the second, it relies on a valuation. If the valuation comes in below the contract price, the lender advances against its own figure, and the difference must be found elsewhere. This is a structural feature of secured lending rather than an opinion about the house.

RRefinancing

Refinancing replaces an existing loan with a new one. The reasons are ordinarily a lower rate, a change of term, a change from adjustable to fixed, or releasing equity.

It is not free. There are closing costs on the new loan, and the amortisation clock restarts, which means the interest-heavy early period begins again. A lower rate on a loan reset to full term can raise lifetime cost even while lowering the monthly payment.