# eli5 mortgage payments.

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alright, i’ve been trying to save and buy a home for years now. might be able to do it this year but im having an incredibly hard time understanding the moving parts of a home loan. excluding everything but the principal and interest on a loan, how does a 7%APR on a loan of \$300k end up making you pay like \$750k over the course of 30 years ??? i also saw that home loans are front loaded for the interest first…. 7% of 300k is 21k but people talk about paying interest for the first 2-3 years of their mortgage… im not totally understanding how the interest is factored into the monthly payment.

In: Economics

mortgage interest rates are an *annual* percentage, not a lifetime of loan value: on a. 7% mortgage, you’re paying 7% for each dollar borrowed that’s not paid back each year that it isn’t (gross oversimplification of interest calculations)

monthly payments of mortgages are usually kept close to constant throughout the life of the loan, and the terms of a loan usually dictate that all interest charged that month has to be paid off that month. as such, without any payments beyond the minimum required, the bulk of the first few payments will be interest.

Let’s use your example of a 300k loan with 7% interest over 30 years. You principle and interest portion of your payment for that loan is going to be \$1,996 for 30 years (because maths)

In the first month you would have accrued 7% of 300k divided by 12 (7% annual, so 0.583%) or \$1,750 in interest.

So you pay the bank \$1,996 but your principle (the amount you still have to repay) only goes down by 246 dollars.

The second month you have smaller principle, but only slightly so you accrue \$1,749 in interest. That month your \$1,996 payment pays off 247 dollars.

All told in the first year you pay a total of \$1,996 * 12 = \$23,940 total to the bank but roughly \$20,900 of that was to pay down accrued interest during that year and you only paid down ~3k of your principle.

As you pay off more, the monthly interest accrued gets lower so you pay off more and more of your principle as you go.

For a 30 year mortgage at 7% it takes nearly 22 years to pay off half of what you owed and then another 8 to pay off the second half

> ??? i also saw that home loans are front loaded for the interest first…. 7% of 300k is 21k but people talk about paying interest for the first 2-3 years of their mortgage…

A point about this: it’s necessary if you want the same payment every month.

If you wanted to pay “1/360th of the principal every month, plus interest” your first payment would be something like \$21,800 (depending on your setup). Your last payment 30 years later would be \$800. By “front-loading” and spreading out the interest, you’ll have a consistent payment every month for 30 years (which generally will benefit you, due to inflation, and means you’ll actually be able to make payments.)

The math works out if you think about it (lower principal = less interest, so paying exactly \$800 a month every month for thirty years is going to slowly tip one way over the other).

There’s nothing stopping you from paying above and beyond your regular payment so you are paying off the principal faster–in fact, plenty of people recommend you do exactly that, if you can.

Also, remember that the “extra interest” you pay is just compound interest. Paying \$750,000 for a \$300,000 house sounds terrible…but after inflation, that \$300,000 is going to be (assuming 3% inflation every year) \$728,178 after thirty years. That money is gonna be worth about the same no matter what, only now you’ve lived in a house for 30 years in addition to owning it at the end.

I got a \$130k home loan and only \$117 a month is going to the principal. I’m so pissed. It seems like this should be illegal!

Other commenters are explaining the amortization schedule which is important to understand. Here’s another perspective: the bank does you a favor by lending you a massive amount of money at once, and there’s risk in doing that because they don’t know if you’ll be able to pay down the whole loan/mortgage fully. This was all willy nilly before 2008 when they basically gave everyone who could breathe a mortgage loan, but now there are strict requirements for a mortgage approval, so banks can be more secure now trusting that a homeowner will actually pay down the loan.

A mortgage loan is massive. If you went to a bank to ask for a personal loan, depending on your income, they’d give you 5-10k at best without collateral. They will ask you what you’re going to spend it on, but because they don’t know for sure, you could abuse their money and never return it, which is why personal loans are much lower than mortgages.

However, with housing, people NEED it. So banks are more willing to give you a large loan to purchase a home because they know it’s a necessity and you will pay it because you want to stay sheltered. That’s why mortgage loans are safer and can be in much bigger sums than a personal loan.

But, the bank is still taking a risk lending you THAT much money. Let’s say it’s a 400k house and you paid 20% down, 80k. They’re still giving you a loan for 320k, which is HUGE for a single person or family. And so, they must make sure that they get paid first, which is why the amortization schedule is structured such that you pay the bank for offering you this giant loan FIRST, which minimizes their risk.

A bank could make more money by splitting that 320k mortgage loan they’re giving you into 10k personal loans at higher interest rates for 32 people, but their risk is higher because of this. That 320k they spent on you is locked up for the next 30 years, to simplify. So they must make a return on the money they lent you because they can’t lend that 320k to other people.

Google mortgage amortization schedule and that will show you very quickly. When first making payments, say your mortgage is \$2500 a month. \$2450 of that goes to interest while only \$50 goes to actually paying down the mortgage.

You pay 7% of your outstanding loan balance every year.

So if you have a loan of 100,000, in the first year you pay 7,000 in interest.

If your repayments are 1,000 a month, the of the 12,000 you pay in a year, 7,000 goes to interest and 5,000 goes to reducing the value of your loan.

For year 2, your remaining loan balance is 95,000. 7% of this is 6,650 – that’s your interest payment. The remainder – 5,350 is paid against your loan balance.

Do this 30 times for a 30 year loan and you’ll end up paying more in interest than you borrowed over the lifetime of the loan.

When getting a mortgage, get the lowest interest rate you can. Ignore “cash back” offers – these are there to distract.

Let me know if you want an excel file which will work all this out for you, and let you play with different amounts of deposit, interest rate etc. and show you your monthly payments etc.