Mortgages in plain terms

Five ideas explain nearly everything a loan does over its life.

A mortgage is a loan secured on the property, repaid on a schedule, with the lender holding a claim until it is discharged. Most confusion about mortgages comes from comparing one number, the rate, when at least five things are moving at once.

Amortisation, and why the early years feel unproductive

Each payment is split between interest on the balance outstanding and repayment of the balance itself. Because interest is charged on what is still owed, the early payments are overwhelmingly interest and the later ones overwhelmingly principal, even though the payment itself never changes. This is why the balance after five years of a thirty-year loan has barely moved, and why an extra payment made early removes far more total interest than the same payment made late.

Term length: two different trades

A shorter term raises the monthly payment and sharply reduces the total interest, because the balance is not outstanding as long. A longer term does the reverse. The honest way to compare them is to look at both figures together, and to ask which risk matters more: the strain of a larger commitment every month, or the cost of carrying debt for another decade.

Fixed and adjustable

A fixed rate fixes the interest rate for the term, and with it the principal and interest portion of the payment. It does not fix the payment as a whole, because taxes and insurance still move. An adjustable rate is fixed for an initial period and then resets periodically against an index plus a margin, within caps stated in the note. The relevant questions about an adjustable loan are always the same: when does it first adjust, how often after that, against what, and what are the caps per adjustment and over the life of the loan.

Points, fees and the rate that is quoted

A point is a fee of one percent of the loan paid at closing in exchange for a lower rate. Buying points is a trade of money now against a smaller payment later, and it pays off only if the loan is held long enough for the savings to exceed the cost. Because points and other charges vary, two loans with the same quoted rate can cost quite different amounts, which is what the annual percentage rate is intended to expose. It is a fairer comparison than the rate alone, though it too assumes the loan is held to term.

Escrow, insurance and the payment people actually make

Many lenders collect property taxes and insurance monthly alongside the loan payment and pay them when due. The account is reconciled periodically, so the total payment changes when the tax bill or the premium changes, even on a fixed-rate loan. Where the down payment is small, mortgage insurance is commonly added as well, protecting the lender rather than the borrower, and it is removed under conditions set out in the loan documents.

Put together: the amount borrowed, the term, the rate and its type, the charges paid to obtain it, and the escrowed items. A loan can only be compared with another loan on all five at once. Which of them suits a particular household is not a question a general article can answer.