Question

Rob Grier, a friend of yours, has recently purchased a home for $125,000, paying $25,000 down and the remainder fi nanced by a 10.5%, 20-year mortgage, payable at $998.38 per month. At the end of the fi rst month, Rob receives a statement from the bank indicating that only $123.38 of principal was paid during the month. At this rate, he calculates that it will take over 67 years to pay off the mortgage. Is he right? Discuss

Answer 1

No, Rob is not right. Monthly payments consist of two parts. One part is interest on the outstanding balance of the loan at the end of each month and the other part is principal amount being repaid. The interest portion included in the monthly payments is higher and the principal portion is lower at the beginning of the mortgage loan but as time passes by the interest portion goes on decreasing and the principal portion increases. This is because with each payment the outstanding balance of the loan gets reduced by the amount of principal included in that payment. So it will not take 67 years to repay the mortgage. Instead it will be paid off in 20 years.