How Do Mortgage Interest Rates Work?
by Cam Merritt
Mortgages are all about percentages.
The interest on nearly all mortgages is computed monthly, so you divide the annual rate by 12 to get the monthly rate. In the case of this mortgage, 7.5 divided by 12 comes out to a monthly rate of 0.625 percent. Every month, you pay 0.625 percent interest on your principal balance--that is, the amount you actually owe on the house.
When it comes time to make your first monthly mortgage payment, your principal balance is $200,000. Applying the monthly rate--0.625 percent--to that amount gives you an interest charge of $1,250 for the first month. That's only part of your first month's payment, though. You'll also pay off a little of the principal. The next month, because
the principal is a little smaller, your interest charge will be a little smaller--which means you can afford to pay a little bit more of the principal.
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