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How Financial Institutions Calculate your Mortgage Payment

If there is one thing we have all learnt since we were kids, it must be that prices can be deceiving. As children, when we buy something we like, the cost on the shelf could be different from the cost on the counter because of the sale tax. However, we didn’t know that those tiny unexpected increments prepared us for the concept of interest and principal amount.

Every economy’s financial institutions thrive on the concept of interest. Since a mortgage is one of the services, financial institutions offer, the idea of interest is an integral part of it, and it, along with the principal amount, makes up the mortgage payment. So, what is this mortgage payment?

Mortgage payment runs on the concept of interest and principal. It is the actual money off your mortgage and the interest you pay your mortgage lender for borrowing you the money you need to buy a house. There’s more; find out all about it as you continue to read.

What is Mortgage Payment

Your mortgage payment is a combination of the principal mortgage payment and the interest. There is not much to say about the principal amount, as it is the actual value of the mortgage itself, with interest being the cost you pay to your financial institution for giving their money to help you get the house you want.

Your principal amount is essential, and it determines the interest you will pay during the cycle of your mortgage payment. You see, your mortgage lender charges you interest on the principal amount that you owe. So, the more you continue to pay down the amount you owe, the more interest you will gradually reduce.

This means that the earliest period of your mortgage is usually the most expensive, as you haven’t made a considerable payment on the principal amount itself. Although if you can make those early days relatively inexpensive if you have enough cash to pay as your initial deposit or down payment. Your interest would be lower when you do this, as you have made headway with the principal amount.

Your mortgage payment comprises monthly payments that you will pay until the mortgage term runs out. The payment depends on the interest rate that the bank offered you, and you accepted it at the beginning of the mortgage. Although you may want to finish paying before the agreed term, it would cost you as mortgage lenders require you to pay a pre-payment penalty or charge if that happens.

Now, since the principal amount is precise as it is the amount you truly need, how about the interest you have to pay, and why do mortgage lenders charge interest anyway? The truth is, interest is how mortgage lenders make their money for providing you with the cash you need.

As you can see, you need to have an idea about how your mortgage lender determines the interest rate you pay. Don’t worry. We promise not to bore you with the mathematical calculations, but you will know what you need to know about interests before you apply and sign for a mortgage term.

How your Financial Institution Calculate your Interest

You might wonder why there is a semblance in interest rate after getting offers from multiple lenders. It does look unfair. It is like the whole Canadian mortgage system wants to fleece you of your hard-earned money.

We can tell you that they aren’t trying to fleece you of your money. In fact, you and your lender have something in common. You both are borrowing money. Shocked? Don’t be. We will make it more straightforward now. Picture this. Your mortgage lender is borrowing money from the government, and as your mortgage lender is charging you an interest rate, the government through the bank of Canada is charging your lender.

Mind blown? Yeah. The interest rate the government charges the bank is the Prime rate, and it is one of the factors that determine the interest rate your mortgage lender charges you. The other factors are;

  • Your Credit Rating
  • Principal Amount.
  • Whether the rates are fixed, variable or hybrid
  • Amortization length
  • Payment Schedule

Credit Rating

Your credit rating comprises your credit report and credit score. Lenders examine these two before they decide to lend you the money you need for your mortgage. These two also determine your interest rate, should mortgage lenders decide to give you the money you need. The poorer your credit rating, the fewer chances you will get a mortgage and the higher your chance of getting an expensive mortgage.

Principal Amount

We have explained this bit about the principal amount earlier on under a previous heading. In summary, the higher your principal amount, the higher your interest. To prevent this, deposit a handsome fee as your down payment.

Whether the Rates are Fixed, Variable or Hybrid

Majorly, your lender would offer you two types of mortgages. Your financial institution could provide you with a fixed-rate or variable mortgage. Fixed-rate mortgage benefits you when your interest is low, as your financial institution will maintain that rate till the end of the mortgage. However, fixed-rate mortgages rarely have low-interest rates. The reason for this is simple.

Your mortgage lender bears risk by fixing the rate for you. Your lender is saying that they will maintain that rate no matter the economic situation.

On the other hand, a variable rate is a rate in flux. Your mortgage lender or financial institution starts with one rate, and during the term of your mortgage, that rate will change. The rate will change due to economic conditions or any other conditions. So, as a borrower, you would be taking on more risks. Fortunately, variable rates have low rates.

There is one more. The hybrid rate combines the qualities of fixed and variable rates. An aspect of your mortgage will have a fixed interest rate. The other part would have a variable interest rate. So, you have the benefits which those two rates offer. For instance, you will be partially protected against an increment in rates. Likewise, you will enjoy some advantages when rates fall.

Payment Schedule

Your payment schedule covers how much time you want to make your mortgage payment. You can choose to have an accelerated payment, which gives you the power to make an extra payment annually. This additional payment comes in the form of a 13th-month payment. You can escape paying more interest this way.

Your Amortization

Your amortization is the time-frame it takes you to complete your mortgage payment. As your amortization increases, your payment reduces. On the other hand, you will pay more interest the longer it is.

Conclusion

As you can see, financial institutions use specific metrics to calculate your interest. You often determine how favorable these calculations will be  when you pass these metrics.

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