If I borrow 100k at 5% interest, and to be paid back in 5 years, why is it not that case that I just pay 21k per year and would have paid 105k after 5 years? I heard that if I pay back a little extra every year, it will help to go pay off the interest first, what does that mean? If I owe a set amount of money on fixed interest, how can the total amount change?
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There are several types of mortgages. Some do work the way you think they should.
I’d like to preface this by saying it’s been about a decade since I went shopping for a mortgage, so some of these may not be used anymore.
You can indeed have the total amount calculated and just pay a fixed monthly amount. It wouldn’t be 105k in your example but something closer to 115/120k, since the interest listed is annual and not total. But the bank can do their fancy calculations and figure out you need to pay 24k (typically in monthly 2k payments) for 5 years to pay the full amount.
There’s also mortgages where you pay a set amount, but most of that payment goes to your interest. It’ll take a while before your payments start making a difference to the amount owed, but in the end nearly everything is paying off the loan and barely any interest remains. Those kinds of mortgages are mostly done for tax purposes (having a large debt is typically a write-off, so people keep the debt and pay the mortgage)
There’s also mortgages that consist of monthly payments+interest. So in your example, you’d pay something like 20k a year (again, monthly payments are typical) but also interest on top of that. So the first year you’d pay 25k total. Second year 24k, etc. It’s nice for people who want to lower their monthly expenses with time. Like young couples thinking of kids in a few years.
There’s probably more I haven’t mentioned, but these were the main three I was taught about a decade ago.
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