The average American pays over $100,000 in mortgage interest over the life of their loan. Small decisions—the rate you accept, the term you choose, whether you make extra payments—compound into massive differences. Let's decode how mortgages work.
How Mortgage Payments Work
Your monthly mortgage payment typically includes four components (PITI):
- Principal: The amount that actually reduces your loan balance
- Interest: What you pay the lender for borrowing money
- Taxes: Property taxes, often escrowed
- Insurance: Homeowners insurance, sometimes PMI
The principal and interest portion is calculated using amortization—a schedule that determines how much goes to each category every month.
Understanding Amortization
Amortization sounds complicated, but the concept is simple: your payment stays the same, but the split between principal and interest changes over time.
In the early years, most of your payment goes to interest. By the end of the loan, most goes to principal. This is why paying extra principal early in your loan has such a powerful effect.
Example: On a $300,000 loan at 6.5% for 30 years, your first payment splits roughly $375 to principal and $1,625 to interest. Your last payment is almost entirely principal. Same payment, very different allocation.
Fixed vs. Adjustable Rate Mortgages
Fixed Rate Mortgage
- Interest rate never changes
- Payment stays predictable
- Protection against rising rates
- Usually higher initial rate than ARMs
Adjustable Rate Mortgage (ARM)
- Lower initial rate (teaser rate)
- Rate adjusts after fixed period (5/1 ARM = fixed for 5 years, then annual adjustments)
- Risk: payments can increase significantly
- Good if you'll sell before adjustment period
Loan Term: 15 vs. 30 Years
30-Year Mortgage
- Lower monthly payments
- More flexibility in budget
- Pay more total interest
- Build equity slower
15-Year Mortgage
- Higher monthly payments
- Lower interest rate (usually 0.5-1% less)
- Pay dramatically less total interest
- Own your home outright faster
The Numbers: A $300,000 mortgage at 6.5%: 30-year costs $382,633 in interest. 15-year (at 6%) costs $156,108. That's $226,000 saved—but your monthly payment is $1,000 higher.
The Power of Extra Payments
Making extra payments toward principal can dramatically reduce your total interest and loan term:
- One extra payment per year: Cuts ~4-5 years off a 30-year mortgage
- Rounding up: Paying $2,000 instead of $1,896 adds up significantly
- Bi-weekly payments: 26 half-payments = 13 full payments per year
Always confirm your lender applies extra payments to principal, not future payments.
What Affects Your Interest Rate
- Credit score: Higher score = lower rate. 760+ gets the best rates.
- Down payment: 20%+ avoids PMI and often gets better rates
- Loan type: Conventional, FHA, VA, USDA have different rate structures
- Points: Prepaid interest that lowers your rate
- Market conditions: Fed policy, economic factors
- Property type: Primary residence gets better rates than investment property
Should You Buy Points?
One point = 1% of loan amount = typically reduces rate by 0.25%. Whether it's worth it depends on how long you'll keep the loan.
Calculate your break-even point: divide the cost of points by monthly savings. If you'll stay in the home longer than the break-even period, buying points makes sense.
Private Mortgage Insurance (PMI)
If your down payment is less than 20%, you'll likely pay PMI—insurance that protects the lender if you default. It typically costs 0.5-1% of the loan annually.
PMI can be removed once you reach 20% equity. Some loans allow you to request removal; others cancel it automatically at 22% equity.
Red Flags When Shopping for a Mortgage
- Pressure to decide immediately
- Rates that seem too good to be true
- Excessive fees or unclear fee structures
- Reluctance to provide written estimates
- Prepayment penalties (rare now but still exist)
Calculate Your Mortgage Payment
See your monthly payment, amortization schedule, and total interest paid.
Open Mortgage Calculator →Final Advice
Get pre-approved before house hunting. Shop multiple lenders—rates and fees vary significantly. Read every document before signing. And remember: what you can borrow isn't the same as what you can afford. Leave room in your budget for repairs, emergencies, and life.