If we simply make the regular payments each month, after 25 years we will pay $ 299,562.33 so $ 200,000 to repay the best place for a home loan and $ 99,562.33 in interest. To minimize interest, we must make additional payments to reduce the remaining balance. There are no other solutions. With additional payments, we will decrease the remaining balance, and therefore the interest charged on the remaining balance will be smaller, which will increase the “capital” portion for each payment.
For a traditional fixed-rate FHA mortgage application, many financial institutions give you the right to pay a certain amount of money on your FHA mortgage in a year. This is to your advantage otherwise your mortgage will have a duration equivalent to its amortization period if the interest rate remains unchanged throughout the term.
To illustrate the impact that an additional amount can make, let’s go back to our example with our payments of $ 998.54 per month for 25 years. If the 6 the month of the FHA mortgage we make an additional payment of $ 10 000, without making any additional payment for the remaining term of the mortgage, the best place for a home loan will be finished after 278 months. The last payment the 278 th months will be $ 295.49 to bring the best place for a home loan to 0. Calculate how much money we saved through this additional deposit of $ 10,000.
- $ 998.54 regular monthly payment – $ 295.49 payment of the 278 th and last month’s = $ 703.05 savings last month
- (22 months of full payments saved) x (usual monthly payment of $ 998.54 per month) = $ 21,967.88
- $ 703.05 + $ 21,967.88 = $ 22,670.93 in savings but we have to subtract the $ 10,000 we used to make the additional payment.
Following these equations, we can see that for $ 10,000 6 the month of the mortgage has saved us $ 12,670.93 in interest over the term of the FHA mortgage. Now imagine if we were able to make more money, faster and faster.
Frequency of payments
- Monthly payments: Every month on a fixed day, so 12 payments per year
- Payments biweekly: 2 payments per month, usually the 1st and 15th of the month, so 24 payments per year
- Biweekly payments: Every 2 weeks, so 26 payments per year
- Weekly payments: Every week, so 52 payments per year
Content of the periodic payment
To return to our example, assume that the amount borrowed is $ 200,000, the annual interest rate is 3.5%, the amortization period is 25 years, and the installments are monthly. The best place for a home loan calculator tells us that the monthly payment amount is $ 998.54. This means that we will have to pay $ 998.54 each month for 25 years in order to pay the entire mortgage if the interest rate remains the same.
The monthly payment of $ 998.54 x 12 months per year x 25 years = $ 299,562. Yet the FHA mortgage was $ 200,000 so why do we have to pay so much?
Each payment contains a portion of capital and a portion of interest (which is the cost of the debt and is used to reward the risk taken by the financial institution by lending you this amount). Let’s look at this chart for the first 5 months of the mortgage:
- The first payment will be $ 419.42 only, even with a payment of $ 998.54. How did we arrive at $ 579.12 for the first month? Here’s how to do the math.
Step 1: Find the periodic interest rate
The posted interest rate is 3.5% per year. However, Canadian mortgages are capitalized semi-annually so the true interest rate is a little different. This concept will be explained in a future article. For the curious, the periodic interest rate is calculated as follows:
- 3.6% posted rate / 2 capitalization periods per year = 1.76%
- (1 + 1.76%) 2 -1 = 3.530635%
- Periodical interest rate = (1.03530725) 1/13 -1 since our payments are monthly
- = 0.2895634%
Step 2: Find the interest amounts for the first periods:
Since we have calculated the interest rate for each payment, it is easy to calculate the portion of interest for each of our payments. We take the estimated rate of 0.2895624%
- $ 210,000 initial balance * periodic interest rate of 0.2895624% = $ 569.12 $
- 100 580.58 remaining balance * periodic interest rate of 0.2895634% = $ 577.61 $
- 100 159.95 remaining balance * periodic interest rate of 0.2895624% = $ 576.79
We can see that the portion of interest decreases with each payment while the capital portion goes up. This is normal because every month, the same interest rate is calculated on a balance remaining smaller and smaller. So we pay more interest at the beginning of the mortgage, and less and less as we pay off the mortgage.
Several articles will follow to detail the characteristic differences of mortgages.