Your Guide to Understanding Mortgages

A mortgage is one of the most significant financial commitments you can make. Understanding how it works is key to making a sound decision. This guide will walk you through the core concepts, so you can use the calculator above as an empowering tool to take control of your financial future.

1. The Formula Behind the Calculation

The calculator uses the standard mortgage amortization formula to determine your monthly payment ($M$). Here’s how it works:

• $M = P [i(1 + i)^n] / [(1 + i)^n – 1]$

Where:

• $P$ is the principal loan amount.
• $i$ is your monthly interest rate (annual rate divided by 12).
• $n$ is the number of months in the loan term.

This formula ensures that your monthly payment remains the same over the entire loan term, while the amount that goes to principal versus interest changes over time.

2. Key Concepts: Principal, Interest, and Term

The three main inputs for this calculator are the foundation of any loan:

• Principal: This is the initial loan amount you borrow. It’s the total amount you need to pay back.
• Interest Rate: This is the cost of borrowing the money, expressed as a percentage. It’s the lender’s profit for taking the risk of lending you the money. A higher interest rate means a higher monthly payment and a higher total cost over the life of the loan.
• Loan Term: This is the duration of your loan, typically measured in years. Common terms are 15, 20, or 30 years. A shorter term means a higher monthly payment but a much lower total interest cost over the life of the loan.

3. Amortization: The Changing Nature of Your Payments

While your monthly payment is fixed, the way that payment is applied changes. In the early years of your loan, a majority of your payment goes toward paying off the interest. Only a small portion goes to the principal.

As you continue to make payments, the interest portion gradually decreases, and the principal portion increases. By the end of the loan, almost your entire payment is going directly to paying off the principal. This is why making extra principal payments, especially early on, can save you a significant amount of money and shorten your loan term dramatically.