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Repaying The Mortgage

There are many variations on how the mortgage loan is paid, depending on locality, tax laws, and prevailing customs.

Capital and interest

The most popular way to repay a mortgage loan is by making regular payments of the capital (the principal) and the interest over a set term. This is called amortization. From the lender’s perspective, this is a form of annuity, and the calculation of the payments is based on the time value of money formulas. Details may vary: interest may be compounded daily, yearly, or semi-annually; prepayment penalties may be applicable; there may be legal restrictions, etc.

Usually, the maximum term for repayment is 25 to 30 years, although shorter periods, such as 15-year mortgage loans are also popular. Typically, mortgage payments are made monthly, and contain a capital and an interest element. The amount of capital and interests in each individual payment varies throughout the term of the mortgage. In the early years the mortgage repayments are mostly interest and small part capital, while towards the end the mortgage payments contain more capital than interest. Some lenders offer a bi-weekly mortgage repayment programs to accelerate the payoff of the loan.

Interest only

An interest-only loan is a loan in which, for a set period of time, the borrower pays only the interest on the principal, with the principal balance unchanged. At the end of the interest-only period, the borrower may enter an interest-only mortgage, pay the capital, or convert the loan to a standard amortized capital-and-interest loan.

A five- or ten-year interest-only period is typical. After this period, the principal balance is amortized for the remaining term. The result is that the early payments (in the interest-only period) are substantially lower than the later payments.

Reverse mortgages

Reverse mortgages are a form of equity release (or lifetime mortgage) available to citizens aged 62 or older, under a federal program administered by the United States Department of Housing and Urban Development (HUD).

Reverse mortgage can be used by elderly homeowners to gain access to the equity that they have worked their entire lives to build. They can choose one of four ways to receive the additional cash from the reverse mortgage: (1) as a monthly payment, (2) in one lump sum amount, (3) as a line of credit, (4) a combination of the mentioned options.

No repayment is required until the borrower(s) no longer occupy the home.

Balloon mortgages

Balloon loans or bullet loans are loans where the payment of the entire principal and sometimes the principal and interest is due at the end of the loan term. The ‘balloon’ refers to the large sum that should be paid at the end of the period. These loans are somewhat less common after the financial crisis.

Mortgage Loan Types

Every day, we hear about many different types of mortgages. We are going to discuss the most common loan types: