For the vast majority of Americans, a mortgage represents the path to homeownership. These loans provide individuals with access to the funds they need to purchase their desired property while simultaneously offering advantageous terms on repayment plans. While this may seem overly advantageous to the borrower, it should also be noted that these funds do come at a price. Interest on mortgage loans can vary based on the financial profile of the borrower.
TL;DR (Too Long; Didn't Read)
When you accept mortgage terms from a lender, they will typically include a detailed overview of your mortgage annual percentage rate, or APR. To create an APR calculator for loans, multiply the decimal-formatted version of this APR by your principal balance to determine exactly how much interest you will owe annually on your loan.
The Basics of Mortgage Loans
A mortgage loan acts as a gateway to homeownership for many people. Without a mortgage loan, financing a home purchase can be extremely difficult, if not impossible. With a mortgage loan, however, individuals can gain access to funds equivalent to the total purchase price of their property minus a sum equivalent to the value of the down payment they made on the property.
When banks receive an application for a mortgage from a borrower, they examine a variety of factors to determine whether or not the borrower's financial health fits within an acceptable risk profile. Although many factors may come into play during this process, some of the most common variables influencing an individual's eligibility for a mortgage include their credit score, employment history and current income.
If an individual is self-employed, they will likely be required to provide even more financial documentation to prove conclusively that they are engaged in stable work and are capable of paying back their mortgage without falling into default.
Mortgage Loans and Down Payments
The size of a mortgage down payment has a direct impact on a borrower's eligibility for financing as well as the specific borrowing terms they will receive if their application is accepted.
The recommended size of a home down payment today is 20 percent of the property's actual value. Although individuals are not directly required to pay this amount, they may be forced to pay for private mortgage insurance in order to "convince" lenders that they do not pose financial risk.
Keeping your down payment as close as possible to 20 percent will help ensure that you receive the best possible interest rates on your mortgage loan. If you are able to pay 20 percent of your mortgage loan upfront, you will also be able to avoid the hassle of paying premiums on private mortgage insurance.
Understanding Interest Accrual
When you take out a loan such as a mortgage, you will be provided with specific details regarding how interest accrues on the principal balance. Generally, interest will either be classified as compounding or noncompounding, simple interest. Understanding the distinction between these two forms of interest is critical, as each carries significant implications for your loan balance.
Compounding and Noncompounding Interest
As an example, imagine a scenario where you accrue 2 percent annual interest on a $200,000 loan. After one year, you will have accrued $4,000 in interest charges. If your loan has compounding interest, this sum will be added back into the principal balance before the next year's interest payments are calculated. With noncompounding, simple interest, future interest calculations are based exclusively on principal rather than the combination of principal and interest.
By and large, the majority of mortgage loans rely on fixed-rate, simple interest lending programs. That being said, borrowers should always review all documentation for their approved loan before committing to this funding to ensure that they are fully aware of the repayment logistics.
The Basics of Amortization
Yet another crucial detail regarding the repayment of your loan is whether or not the loan is fully or partially amortized. Amortization describes the process of parsing accrued interest into the regular monthly mortgage payments in such a way that both interest and principal are being repaid on the loan over time. With a fully amortized loan, the full principal and interest balance will be repaid by the time the last recurring payment is made.
However, partially amortized loans will often feature reduced monthly payments compared to fully amortized loans in exchange for a required balloon payment at the end of the mortgage lifecycle. In addition to APR calculators for loans, you can find a variety of amortization calculators online, such as this one from Bankrate, that will clearly dictate how these payments will be spread out over the lifecycle of your loan.
For some borrowers, these reduced payments may be advantageous. That being said, it is critical to consider whether or not the final mandated balloon payment will stress your personal finances beyond a reasonable level.
Mortgage Loans and Interest Payments
Lenders will provide potential borrowers with a detailed overview of their borrowing options, including required interest rates, following the acceptance of their application. Simply put, APR represents the percentage of the loan principal that will be used to calculate interest payments for the year.
So, for example, if a mortgage loan of $500,000 had an APR of 1.6 percent attached to it, the total amount of interest that must be paid for the year is $8,000. This answer can be calculated by first converting the APR percentage into decimal form. To do this, divide the percentage by 100 to convert it to decimal form. So, APR of 1.6 percent would be converted to .016. Next, you can multiply this figure by the total principal balance of the loan to determine exactly how much interest must be paid (500,000 * 0.016 = 8,000).
Keep in mind that you will receive reports dictating the amount of interest that has accrued on your mortgage even though you will likely never pay into a separate "interest" balance on your loan. As mentioned previously, the amortization process blends interest and principal payments together over the lifespan of your loan.
APR Calculators for Loans
If you have any additional questions about your APR or loan in general, it is best to discuss these with a bank representative or financial adviser. The serious implications of mortgage defaulting make it imperative for you to fully understand when and how your loan will be repaid. These individuals can also help you create a mortgage APR calculator with PMI, if this applies to your specific situation, or you can access a simple APR calculator online. Fortunately, a variety of resources are available to ensure that you handle these payments responsibly.
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community.