What is Mortgage Interest?

Introduction

Mortgage interest is simply the interest amount the borrower pays to the lender who holds the mortgage. This is done in equal monthly installments. The installments always include portions of principal and the interest. Principal is the amount of loan you get from the lender and interest is the amount the lender charges you to borrow the money.

Installment Structure

We saw earlier that every monthly mortgage installment includes portions of principal and interest. In the first five to ten years of the loan tenure more than half of the installment is constituted by the interest amount. As the mortgage amortizes and the repaid principal grows, the amount of interest applied to the balance portion of principal decreases. This way, the amount of interest in the installment decreases with time.

It is mandatory for the lender to provide a document called ‘truth in lending disclosure’ while sanctioning a loan. This document states the mortgage interest rate, amortization schedule, total amount the borrower pays towards interest and total amount the payments add up to at the end of the loan term. The statement can look quite intimidating at first glance.

Different Kinds of Interest Schemes

There are different packages of mortgage interest rates. Most mortgages come with fixed interest rate, which means that the interest rate at the time of sanctioning the loan applies for the whole loan tenure. Variable interest rates on the other hand mean that the interest rate can increase or decrease. There are also packages where the interest rate remains fixed for a period and then get into variable mode, or start with a variable mode and then change into fixed mode. Mortgage interest standards change very often- almost on a day to day basis- however the rates tend to vary slightly among lenders.

Tax Benefits

Although all mortgages are liable for interest, you can use your mortgage interest to apply for tax deduction. In most cases, you can avail tax deductions on 100% of primary mortgage. Mortgage interest from a second mortgage or equity loan also can be used to apply for tax deduction in some cases. The mortgage company is required to give the borrower annual statements of the mortgage interest you paid during the tax year. You can use this statement to apply for tax deductions for the corresponding year.

However there are certain regulations according to which you may not get tax deductions if the mortgaged property is not your primary residence. This applies if the mortgage is on rental or investment property. In this case you will need the advice of a tax consultant.