Understanding Mortgage Repayments: Strategies For Reducing Debt

A mortgage is a long-term loan that allows consumers to purchase property and pay for it over time. The property acts as collateral for the loan, and the monthly payments consist of principal, interest, taxes, and insurance. The amount borrowed with a mortgage is called the principal or mortgage balance, and each month, a portion of the monthly payment goes towards paying off this principal, while the rest pays the interest on the loan. Over time, as the principal is paid down, the interest owed decreases, and a larger portion of the monthly payment goes towards paying off the principal. This process is known as amortization, and it results in the borrower gradually building equity in their home.

Higher repayment frequency leads to faster decrease

When taking out a mortgage, you can choose how often you wish to make repayments on your loan. The frequency of your repayments will determine the size of your repayments and the time it takes to repay your loan. The more frequently you make mortgage repayments, the faster you reduce the principal, saving you interest. This is because the amount of interest on a loan will get smaller as the principal balance is paid off.

For example, let's say you have a 30-year loan for $500,000 at an interest rate of 4.24%. If you opt for monthly repayments and start paying an extra $100 every month after the first year of your loan, you could save $30,558.35 in interest and reduce your loan term by 2 years and 1 month. On the other hand, if you choose to make fortnightly payments, you will pay half of the monthly repayment every two weeks, resulting in 26 payments per year. This will save you $62,715 in total interest compared to monthly repayments. If you make weekly payments, you will pay one-fourth of the monthly repayment each week, resulting in 52 payments per year. This will save you $63,050 in total interest compared to monthly repayments.

The higher repayment frequency leads to a faster decrease in the mortgage balance because the interest is calculated based on the outstanding principal balance. By making more frequent payments, the principal balance is reduced faster, which results in lower interest charges over time. This strategy can potentially save you thousands in interest expenses over the life of your loan.

It is important to note that while increasing the repayment frequency can lead to faster debt reduction, it may not be suitable for everyone. It is essential to consider your financial situation and ensure that you can afford the higher repayment amount. Additionally, some lenders may have restrictions on the repayment frequency, so it is advisable to review the terms of your loan agreement.

Interest and principal repayment

A mortgage is a long-term loan that helps you buy a house. The amount you borrow with your mortgage is called the principal or the mortgage balance. Each month, part of your monthly payment goes towards paying off the principal, and part pays interest on the loan. Interest is what the lender charges for lending you money. The interest rate on a mortgage directly impacts the size of a mortgage payment—higher interest rates mean higher mortgage payments.

In the early stages of a mortgage, the majority of your monthly payment goes towards interest. Over time, as you pay down the principal, you owe less interest each month because your loan balance is lower. This means that more of your monthly payment goes towards paying down the principal. Near the end of the loan, you owe much less interest, and most of your payment goes towards paying off the last of the principal. This process is known as amortization.

The amount of interest included in your monthly mortgage payment varies inversely with the amount of principal included. At the beginning of your home loan, your payments will include a higher proportion of interest. Towards the end of your loan, that proportion will be much lower.

You can choose how often you wish to make repayments on your loan. Typically, you will have the option to repay your loan on a monthly, fortnightly, or weekly basis. The more frequently you make mortgage repayments, the faster you reduce the principal, saving you interest.

Property insurance

When taking out a mortgage, you may be required to get property insurance, also known as private mortgage insurance (PMI). This type of insurance is mandatory if you buy a home with a down payment of less than 20% of the cost. It protects the lender if you, the borrower, are unable to repay the loan. By minimising the default risk on the loan, PMI enables lenders to sell the loan to investors, who can be assured that their debt investment will be paid back.

PMI does not protect you but instead protects the mortgage lender if you stop paying back your loan. It is different from mortgage protection insurance (MPI), which pays off the remainder of your mortgage if you pass away or become disabled and can't work. MPI functions similarly to life insurance and disability insurance, but the payment goes directly to the lender to pay off the loan, rather than to you or your heirs.

With PMI, you are typically required to pay until you accumulate 20% equity in your home, either by paying down your loan per the repayment schedule, prepaying your loan, or having your home reappraised. Most PMI is paid monthly, with little or no initial payment required at closing. Under certain circumstances, you can cancel your PMI. For example, if you get a Federal Housing Administration (FHA) loan, your mortgage insurance premiums are paid to the FHA, and you can cancel once you have at least 20% equity in your home.

While MPI can provide peace of mind and emotional relief, knowing that your loved ones won't be burdened with mortgage payments if you pass away, there are also some downsides to consider. The premium remains the same, but the death benefit declines over time as your loan balance decreases. Since the death benefit only goes towards the home loan, MPI won't help your loved ones with other expenses related to your passing. Additionally, the extra cost of MPI may be a financial burden if you're already stretched thin.

In summary, while property insurance or PMI is necessary to protect the lender and facilitate certain loan options, MPI is an optional policy that offers peace of mind but comes with financial drawbacks.

Private mortgage insurance

PMI is arranged by the lender and provided by private insurance companies. The cost of PMI, called a "premium", is typically added to the borrower's monthly mortgage payment. However, it is sometimes paid as a one-time upfront premium at closing, or with a combination of upfront and monthly payments. The upfront premium is shown on the Loan Estimate and Closing Disclosure. The monthly premium is shown in the Projected Payments section of the Loan Estimate and Closing Disclosure.

PMI is not a permanent fixture of a mortgage. Lenders are required to cancel it when the mortgage balance drops to 78% of the home's original value, or once the borrower is halfway through the loan term, whichever comes first. The borrower can also request that the lender removes the PMI once their mortgage balance is less than 80% of the original appraised value of the home.

There are alternative options to taking out a conventional loan with PMI. Government-backed loans, such as FHA loans, USDA loans, and VA loans, require a smaller down payment or no down payment at all.

Repayment plans

A mortgage is a long-term loan that helps people buy a house. The amount borrowed with a mortgage is called the principal or the mortgage balance. The home and the land around it serve as collateral. In addition to repaying the principal, the borrower also has to make interest payments to the lender. Interest is the lender's reward for taking a risk and loaning the money. The interest rate on a mortgage directly impacts the size of a mortgage payment. Higher interest rates mean higher mortgage payments.

The borrower can choose how often they wish to make repayments on their loan. The repayment frequency determines the size of the repayments and the time it takes to repay the loan. The more frequently the borrower makes mortgage repayments, the faster they reduce the principal, saving them interest. For example, weekly payments are calculated by dividing the monthly repayment by the number of weeks in a month, which is four.

The amount of interest included in the monthly mortgage payment varies inversely with the amount of principal included. At the beginning of the loan, the payments include a higher proportion of interest, while towards the end, that proportion is much lower. The borrower pays more interest in the early part of the mortgage, while the latter part favours the principal balance.

Frequently asked questions