As we head toward Christmas, many families are spending money and putting a fair amount of those purchases on credit cards. Whether or not a person pays off their credit card debt immediately or over time is a matter of personal choice, but it does remind us of interesting mortgage questions that Orion’s brokers often hear from clients: “Why are mortgage payments mostly interest?” and “Can I pay off my mortgage early over time?”

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The way mortgages are set up here in the United States, for Orion and other lenders, are that each monthly payment is the same amount, assuming it’s a fully amortizing fixed-rate mortgage, which most tend to be. This keeps housing payments more affordable (and predictable) because the balance is paid off evenly over a long period of time, such as 30 years.

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However, even though the payment is fixed, the composition of the payment will change monthly until the loan term ends. Each month, the borrower would need to make the same payment to the lender in order to satisfy the entire balance in 30years. The amount would never change, though as mentioned, the composition would. In fact, it would change every single month during the loan term. In short, the first payment on a mortgage is “mostly interest.” As the months goby, principal increases and interest drops.

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Why is this? Well, brokers should tell clients to remember the first month’s principal payment lowered the outstanding principal balance. As a result, the interest due on the second monthly payment dropped, and the principal increased, because as noted earlier, the payment amount stays constant. Over time, this trend continues. The principal portion of the monthly mortgage payment increases while the interest portion drops. It’s pretty minimal in the beginning because little principal is paid each month with such a large balance demanding so much interest each month. This is the “front loaded” argument your clients hear about: how interest makes up the lion’s share of early payments. It’s not a gimmick, just the way math works.

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But in month153, or nearly 13 years into a 30-year mortgage, the principal portion of the mortgage payment finally surpasses the interest portion. In other words, the lender or servicer still very much owns your client’s home, even though they think they’re the “king of your castle.

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However, this is where the principal really starts to get paid down, as interest finally takes a back seat. During the final year of the loan term, each monthly payment is more than 96% principal, with very little interest due because the outstanding balance is so low.

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In reality, many homeowners don’t hold their mortgages for the full term. In fact, most are said to hold their loans for a fraction of the loan term, such as seven or eight years before refinancing, prepaying the mortgage, or selling the home. Many borrowers make additional payments during the year (due to receiving a bonus, for example) which lead to a straight reduction of the amount of principal outstanding. It’s for this very reason that mortgage payments tend to be mostly interest. Because many borrowers never get to the point where the principal actually surpasses the interest.

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If your clients have questions about how loans amortize and pay off overtime, it is a great way for brokers to add value!