The 30-year fixed-rate mortgage: how the payment is built

In the United States, the typical home loan is a fixed-rate mortgage with the same payment every month for 15 or 30 years. Freddie Mac's weekly Primary Mortgage Market Survey (opens in a new tab) reports the average rate for exactly those two products. This guide explains where the payment comes from, why so little of it goes to the debt in the first years and what paying extra changes. The figures are an illustration on a round number, not a market quote.

How the payment works

A fixed-rate mortgage is a level-payment loan: the same math as the PRICE system, described in the guide on PRICE or SAC. Each month the interest is the balance times the rate for the month, which is the yearly rate divided by twelve, and what is left of the payment reduces the balance. Because the balance is highest at the start, the interest is highest at the start, and the early payments are mostly interest. The payment never changes, so the share that reduces the debt grows slowly and, in the last years, becomes most of each payment.

An example with numbers

A mortgage of US$ 300,000.00 over 30 years at 6.50% a year. The rate is only an illustration.

Of the first payment, US$ 1,625.00 is interest and only US$ 271.20 reduces the debt. After five years, 60 payments in, US$ 94,605.26 has gone to interest and only US$ 19,166.74 to principal: the balance has fallen from US$ 300,000.00 to US$ 280,833.26. The total interest over the life of the loan is more than the amount borrowed, which is the price of spreading the payment over 30 years.

A shorter term, at the same rate

The same US$ 300,000.00 at the same 6.50%, over 15 years instead of 30:

The payment is about 38% higher and the interest is less than half. In practice, lenders usually quote a lower rate for the 15-year loan, as the Freddie Mac survey generally shows, which widens the gap; the table keeps the rate equal to show only the effect of the term.

What paying extra changes

Money paid on top of the payment goes straight against the balance. Paying US$ 200.00 extra every month on the same 30-year loan puts in US$ 55,200.00 in total, avoids US$ 103,450.19 of interest and removes 83 payments, almost seven years. The guide on paying a loan off early explains how this works and what to ask the lender.

What the payment does not include

The payment above is principal and interest only. The monthly cost of owning the home is usually higher:

• Property taxes and homeowner's insurance, which many lenders collect with the payment and hold in an escrow account.
• Mortgage insurance, which may be required when the down payment is small. On a conventional loan, private mortgage insurance can be cancelled on request once the balance reaches 80% of the home's original value and ends automatically at 78%, under the Homeowners Protection Act; FHA loans follow other rules.
• Maintenance and association fees, which are not part of the loan at all.

Ask the lender for a breakdown of the whole monthly payment, not just the principal and interest.

Before you sign

Check the interest rate and the APR, which are not the same figure: the guide on the APR in the US and Europe explains why. Check also whether the loan has a prepayment penalty. Since 2014 one is allowed only on fixed-rate loans that are qualified mortgages and are not higher-priced, and only in the first three years, capped at 2% of the balance repaid in the first two and 1% in the third. Most ordinary loans have none, but the terms are written in the loan documents.

How to try it with your numbers

In the simulation, choose the United States, enter the amount and the term in months (360 for 30 years), pick the PRICE system and a nominal rate per year, and read the schedule: the first rows show how little of the payment reduces the debt. The comparison between a 15-year and a 30-year loan is two runs of the same loan with different terms.