While almost everyone takes out a mortgage at some point, not too many people actually realise the details about these loans before they contact the bank or lender. By informing yourself about the payment structure of these credit options, you’ll then have a better chance of making a smarter borrowing decision that helps rather than hinders your finances.
Determining Monthly Payments
Although there are many different varieties of home loan available, the amount of money you’re expected to repay every month will depend on two major factors:
- The size of the loan you’re taking out
- The term you and the lender agree to
In general, loans with longer terms will come with lower monthly repayments. If the term is too long though, the total amount of interest paid will increase dramatically. For this reason, 30 year mortgages are the most popular with borrowers these days. However, it will help to know the specifics of the repayments you make so you know which term will ultimately be best for you and your financial situation.
Basic Payment Components
When it comes to the makeup of each payment, there are four different components that you will have to consider:
- The Principle: This is the money you have borrowed to cover the value of the real estate minus the required deposit. For instance, a home worth $540,000 with a deposit of $27,000 will have a principle of $513,000.
- The Interest: This is the reward the bank gets from lending their capital. In general, the higher the interest rate is, the higher your monthly repayments will be. Let’s say you are borrowing $513,000 for 30 years. A rate of 4.85% per annum will equate to monthly repayments of $2,707.06 per month. Compare this with a rate of 6.7% per annum which equates to monthly repayments of $3,310.28. As you can see, the amount of interest will affect whether you can afford the loan or not!
- Property Taxes: These are calculated by the government on a yearly basis. Get advice on stamp duty and other taxes for home loans in Australia to get the specific details about your state. In general, these additional fees can be included within the monthly payments so you don’t have to cover a major transaction once a year once tax season comes around.
- Insurance Cover: Lastly, your monthly repayments will have to include two types of insurance to protect you and the lender. Home and contents insurance is essential so you can still cover costs in case of fire, theft and other calamities. You’ll also need private mortgage insurance (PMI) to protect the lender in case you can’t pay back the loan. This can be dropped once you have paid off a significant percentage of your mortgage though.
When taking out any home loan, chances are that the monthly repayments you have to make will contain each of these four components. It is important to find out the details so you can calculate how quickly you’ll be able to pay back the principle amount.
The Amortisation Schedule
Even though your monthly repayments are fixed, their makeup will vary over time. This is because the principle will gradually decrease with each repayment, meaning that the amount of interest charged will also drop. Thus, you’ll be able to pay back a larger percentage of the principle with each payment you make. In financial terms, the process of allocating money to principle and interest is called amortisation. In the example given before, we’ve borrowed $513,000 at 4.85% per annum for 30 years. Remembering that our monthly payments were $2,707.06, this will give us the following payment breakdown for the specified months:
- Month 1: Interest ($2,073.38), Principle ($633.68)
- Month 120: Interest ($1,682.99), Principle ($1,024.07)
- Month 240: Interest ($1,045.42), Principle ($1,661.64)
- Month 360: Interest ($10.90), Principle ($2,696.16)
As time passes, the amount of interest that makes up each loan will decrease (gradually at first and more rapidly at the end). The total amount paid back each month will remain the same however.
This guide should give you the basics on how your monthly mortgage repayments will be structured. Since you’re now better informed, making sense of your home loan should be easier to accomplish!
