Mortgage Payments 101

A mortgage payment consists of two crucial parts: principal and interest.

Principal 

The principal of the mortgage payment is applied towards the outstanding balance of a loan. In simple terms, if you bought a home for $500,000 and made a $50,000 down payment, your mortgage payment would go towards paying a $450,000 principal.

Interest

Mortgage interest is what your lender will charge you for borrowing the money. When you pay towards your mortgage, lenders usually cover interest first and then make payments towards your principal. As your loan matures, you will pay less in interest and more in principal.

You can usually make extra principal payments towards your principal and reduce the amount you owe gradually.

Lastly, you may also come across homeowners’ insurance and property tax costs built into your mortgage payment. Being aware of the connection between these is essential to understanding the general makeup of your mortgage.

Type of mortgages

There are several types of mortgage payments available in the United States. They are generally offered on a 15 to 30-year term and come with different interest rates. The most common loan types include:

1. Fixed-rate mortgage: These mortgages hold the same interest rate throughout your mortgage. They can range from 10 to 30 years and help you maintain the same monthly payment.

2. Adjustable-rate mortgage: Adjustable-rate mortgages are volatile in that the interest rates fluctuate with market conditions. This can be a risky option if you have varying incomes or cannot pay a higher mortgage payment. 

3. Conventional mortgage: A conventional loan is not backed by the federal government. You can get a conventional loan with as little as 3% down.

4. Government-insured mortgage: Government-insured loans are loans guaranteed by the government. They help more Americans become homeowners when they don’t qualify for conventional mortgages. Common examples include FHA, USDA, and VA loans.

Now that we have a general understanding of mortgage payments and the types of mortgages available let’s look at the key differences between monthly and bi-weekly payments. 

Monthly mortgage payments

The monthly mortgage arrangement is prevalent among most homebuyers. Most mortgage programs require you to make monthly payments. Under this method, you make a single monthly payment for a total of 12 payments throughout the year.

If you are wondering what that payment might look like, several factors can affect how much your monthly payment is, including your credit score and down payment. For reference, The average monthly mortgage payment in the US is $1,275 on a 30 year fixed mortgage.

Pros

The monthly mortgage payment is ideal for convenience and stability. If you know when your mortgage is due, you will plan your finances around that and generally have more flexibility in your budget compared to a bi-weekly payment method.

Cons

A downside to paying monthly is the potential interest you could be paying over the lifetime of the mortgage. While you may pay less month to month, depending on the plan, you may pay more mortgage interest than a bi-weekly payment throughout your loan agreement. 

Bi-weekly payments

Bi-weekly payments are structured as 26 payments or the equivalent of 13 monthly payments. This extra month is what gets folks excited about this plan. This plan offers the chance to pay your principal faster and pay less in mortgage interest. That could save you thousands over the lifetime of your mortgage.

For example: Let’s say you purchased a home for $300,000 with a rate of 3% and a 30-year term. If you chose the monthly option, the interest you would pay would be $347,226.39 compared to the bi-weekly interest of $273,074.20. That’s a $74,000 difference! Not bad at all.

To compare, you can do your own additional calculations by using a bi-weekly mortgage calculator.

Pros

Outside of paying less in interest, you will be able to build equity in your home much faster. Equity amounts to the value of a homeowner’s interest in their home. With more equity in your home, you not only own more of your home, but you can use that equity to grow your wealth by potentially purchasing a new home or making renovations to your existing home and increasing its value. 

Cons

Some lenders may charge you a setup fee to schedule bi-weekly payments. This helps them recoup any lost interest they may have from paying your loan interest faster. Check with your lender before considering this move to see what the additional costs may be. 

There is also the risk of the payments not being applied every two weeks. This arises when a mortgage company holds each month’s first payment and only sends it to the lender when they receive the second payment. In that case, the mortgage payment acts as a monthly payment since it is essentially being applied every month. It may also be good to look at your budget to truly see if you are getting ahead with this plan in place.

Which option should I use? 

The question that we must now ask is which option is better for me? Short answer: it depends. Some homeowners may notice significant savings when they move their payments to bi-weekly, while others may not see the same results. It is important to always do your research and speak to a certified professional to see if either of these options makes sense for you.

Let us know what you think! Do you prefer paying monthly or bi-weekly on your mortgage?