Questions: Mortgages and Home Buying

Question 1

In the early years of a 30-year amortizing mortgage, what is true about how your monthly payment is allocated?

• A. Most of the payment goes toward principal, with a small fraction to interest
• B. The payment is split evenly between principal and interest throughout the loan
• C. Most of the payment goes toward interest, with a small fraction to principal
• D. The entire payment goes to interest until the loan is half paid off

Answer: (C)

In amortization, each payment's interest portion equals the current outstanding balance times the monthly interest rate. Because the balance is highest at the start of the loan, interest consumes the largest share of early payments. Over time the balance shrinks, so the interest portion falls and the principal portion grows — even though the payment amount stays the same. This is why early extra payments have such a large payoff: they reduce the principal on which all future interest is calculated.

Question 2

Buying a home is typically financially superior to renting because mortgage payments build equity while rent is simply 'thrown away'.

• T. True
• F. False

Answer: False

This is one of the most common financial misconceptions. Homeownership carries real costs beyond the mortgage payment: property taxes, homeowner's insurance, maintenance (typically 1–2% of home value per year), and the opportunity cost of the down payment (which could otherwise be invested). Renting also offers flexibility and avoids market risk. Whether buying beats renting depends on how long you stay, local price-to-rent ratios, investment alternatives, and personal circumstances. Neither is universally better.

Question 3

Why does your credit score have such a large effect on the total cost of a mortgage?

Model answer: Because mortgage interest rates are risk-priced: lenders charge higher rates to borrowers they consider higher risk of default. A higher credit score signals lower risk, which earns a lower interest rate. Over a 30-year loan, even a 0.5–1% difference in rate can translate to $30,000–$70,000 more in total interest paid on a $300,000 loan.

This is compound interest working against you at scale. A small rate difference, applied to a large balance over many years, accumulates into a very large total cost difference. This is why optimizing your credit score — paying down balances, correcting errors on your report — before applying for a mortgage is worth significant effort.