How Mortgage Interest Works

Historically low interest rates have buyers and current homeowners asking how they can make the most of their financial situations. While prices have gone up almost everywhere in the District, low rates have kept the payments affordable and day-to-day, that's really what matters. The less you pay in mortgage interest, the higher the sales price you're able to afford and still remain within your budget.  
   
Your mortgage payment is made up of four parts sometimes referred to as PITI: principal (the amount that goes toward paying down your original loan amount), the interest, property taxes (if you chose to pay them with your mortgage), and homeowner's insurance. Private mortgage insurance only applies if you've financed more than 80% of the value of the home. The interest is what lenders charge in exchange for giving you hundreds of thousands of dollars to purchase your home and what makes them a profit.   
   

The interest rate that is quoted is a percentage of your loan amount that you'll be paying in addition to paying back the loan. For instance, if your mortgage is $500,000 and your interest rate is 3.5%, then you're going to be paying 3.5% of $500,000 ($17,500) each year in interest. So when you make your first mortgage payment, you're (theoretically) paying 1/12th of $17,500, or $1,458.33, in interest. If your total mortgage payment is $2,500, then you're paying $1,041.67 towards your loan balance.   

   
Next month, your loan amount is $498,958.33, 3.5% of that is $17,463.54, and 1/12 of that is $1,455.30. So your second mortgage payment will pay $1,455.30 towards interest and the remainder ($1,044.70) towards principle. And so on and so on 358 more times until your principle balance is zero.    
   
As you can tell, most of your money for the first several years will go toward interest instead of principal. Luckily, there's the mortgage interest deduction that takes some of the sting out of that realization. And the longer you own your home, the more principal you pay, the less interest, and the more equity you accrue. Thus the magic of homeownership.   
   
Does that sound daunting? Don't worry. I know some excellent lenders who can not only pre-approve you for a loan, but also educate you and consult on the entire process.