On a level-payment, fully amortizing fixed-rate mortgage, how does the composition of the payment generally change over time?
Correct Answer
C) Interest generally falls and the principal portion rises as the balance declines
Why this is correct: On a fully amortizing, level-payment fixed-rate mortgage, the total monthly payment (principal + interest) remains constant. However, the interest portion of each payment is calculated on the remaining loan balance. Since each payment reduces the principal, the balance declines over time. A lower balance means less interest accrues each period. With a fixed total payment, a smaller interest portion leaves a larger portion of the payment to apply to principal. Therefore, over the life of the loan, the interest portion generally falls while the principal portion rises. Why the other choices are wrong: The choice "Both principal and interest portions remain identical" is incorrect because only the total payment is level; the allocation between principal and interest changes. The choice "The principal portion falls while interest rises" is incorrect because it reverses the actual relationship; interest falls as the balance declines. The choice "No principal is paid until the final month" describes a balloon or interest-only loan, not a standard fully amortizing mortgage. Exam tip: Remember the phrase "front-loaded interest" for amortizing loans. Early payments are mostly interest; later payments are mostly principal.
Why This Is the Correct Answer
Why this is correct: On a fully amortizing, level-payment fixed-rate mortgage, the total monthly payment (principal + interest) remains constant. However, the interest portion of each payment is calculated on the remaining loan balance. Since each payment reduces the principal, the balance declines over time. A lower balance means less interest accrues each period. With a fixed total payment, a smaller interest portion leaves a larger portion of the payment to apply to principal. Therefore, over the life of the loan, the interest portion generally falls while the principal portion rises. Why the other choices are wrong: The choice "Both principal and interest portions remain identical" is incorrect because only the total payment is level; the allocation between principal and interest changes. The choice "The principal portion falls while interest rises" is incorrect because it reverses the actual relationship; interest falls as the balance declines. The choice "No principal is paid until the final month" describes a balloon or interest-only loan, not a standard fully amortizing mortgage. Exam tip: Remember the phrase "front-loaded interest" for amortizing loans. Early payments are mostly interest; later payments are mostly principal.
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