Understanding Interest Rates: How They Impact Your Home Loan

How Does Mortgage Interest Work?

When you take out a mortgage to buy a home, part of your monthly payment goes toward the loan balance (principal) and part goes toward interest. Interest is the cost of borrowing money, and it’s calculated as a percentage of your remaining loan balance. In the early years of your mortgage, a larger portion of your payment goes toward interest. Over time, as your loan balance decreases, more of your payment goes toward paying off the principal.

What is Mortgage Interest?

Mortgage interest is what a lender charges you for borrowing money to buy a home. The interest rate you receive depends on several factors, including your credit score, debt-to-income ratio (DTI), loan amount, and current market conditions. A lower credit score or a high DTI may result in a higher interest rate because lenders see these as signs of increased risk.

Mortgage Interest vs. Principal

Your monthly mortgage payment consists of two key components:

• Principal – The original loan amount you borrowed.

• Interest – The cost of borrowing that money.

Interest is calculated as a percentage of your loan balance. As you make payments and reduce your principal, your interest payments decrease as well.

How is Mortgage Interest Calculated?

Lenders determine your mortgage interest rate based on several financial factors, including:

• Your down payment size

• Credit score

• Debt-to-income ratio (DTI)

• Current market rates

• Fixed-rate vs. adjustable-rate mortgage (ARM)

• Loan-to-value ratio (LTV)

Your lender will provide an amortization schedule, which breaks down each monthly payment into principal and interest over the life of the loan. This schedule helps you see how much of your payment goes toward interest versus reducing your loan balance.

For example, on a 30-year fixed mortgage of $200,000 with a 6.57% interest rate and a $1,273 monthly payment, the first few months look like this:

Month	Interest Payment	Principal Payment	Remaining Balance
1	$1,094	$179	$199,822
2	$1,093	$180	$199,642
3	$1,092	$181	$199,462
4	$1,091	$182	$199,281

By the end of the loan, most of your payment will go toward principal rather than interest.

Mortgage Interest vs. APR

Your mortgage interest rate and annual percentage rate (APR) are not the same.

• Interest rate is the cost of borrowing the loan principal.

• APR includes the interest rate plus additional fees like mortgage points, closing costs, and lender fees.

How Interest Works with Different Mortgage Types

• Fixed-Rate Mortgage: Your interest rate stays the same for the life of the loan, providing predictable payments.

• Adjustable-Rate Mortgage (ARM): The interest rate starts fixed for an initial period, then adjusts periodically based on market conditions.

• Interest-Only Mortgage: For a set period, you only pay interest, making monthly payments lower. Later, principal payments begin, increasing the monthly cost.

• Jumbo Loan: Larger than standard loan limits, these often have higher interest rates.

• Reverse Mortgage: Designed for homeowners 62 and older, interest accrues over time instead of being paid monthly, increasing the loan balance.

What’s a Good Mortgage Rate?

A good mortgage rate varies based on market conditions. In early 2024, mortgage rates range from 6% to 7%. Rates fluctuate based on economic trends, inflation, and Federal Reserve policies.

How to Get the Best Mortgage Rate

• Improve Your Credit Score: Pay bills on time and reduce outstanding debts.

• Lower Your Debt-to-Income Ratio: Aim for a DTI below 35% to show lenders you can manage payments.

• Save for a Larger Down Payment: A higher down payment can help you secure a lower interest rate and avoid private mortgage insurance (PMI).

• Shop Around for Lenders: Compare offers from different lenders to find the best rate and terms for your situation.

• Consider Mortgage Points: Buying points at closing can reduce your interest rate, lowering monthly payments.

Is Mortgage Interest Tax Deductible?

Yes, mortgage interest is tax-deductible in most cases. Homeowners can deduct interest on the first $750,000 of their mortgage for a primary or secondary home. For married couples filing separately, the limit is $375,000 per person. Always check with a tax professional to understand your specific deduction eligibility.

Final Thoughts

Understanding how mortgage interest works can help you make informed financial decisions and potentially save thousands over the life of your loan. Whether you’re buying your first home, refinancing, or planning ahead, taking the time to research and compare options can lead to better terms and long-term savings. By staying informed and proactive, you can make smart financial choices that align with your homeownership goals.

* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.