Why is the interest portion of a level fixed-rate mortgage payment usually larger near the beginning of the loan?
Correct Answer
C) Interest is calculated on a larger outstanding principal balance
Why this is correct: Monthly interest is calculated by applying the periodic interest rate to the outstanding principal balance. At the beginning of the loan, the outstanding balance is at its highest. Therefore, the dollar amount of interest due is largest. Since the total P&I payment is level, a larger interest portion leaves a smaller portion to reduce principal early on. Why the other choices are wrong: The choice "The note rate changes each month" is incorrect; by definition, the note rate on a fixed-rate mortgage is constant. The choice "Escrow is treated as interest" is incorrect; escrow funds for taxes and insurance are separate from interest and do not affect the allocation of the P&I payment. The choice "No principal reduction is permitted in the first year" is incorrect; standard fully amortizing loans reduce principal with every payment from the very first one. Exam tip: Link the high initial interest portion directly to the high starting balance. It's simple math: Interest = Balance * Rate.
Why This Is the Correct Answer
Why this is correct: Monthly interest is calculated by applying the periodic interest rate to the outstanding principal balance. At the beginning of the loan, the outstanding balance is at its highest. Therefore, the dollar amount of interest due is largest. Since the total P&I payment is level, a larger interest portion leaves a smaller portion to reduce principal early on. Why the other choices are wrong: The choice "The note rate changes each month" is incorrect; by definition, the note rate on a fixed-rate mortgage is constant. The choice "Escrow is treated as interest" is incorrect; escrow funds for taxes and insurance are separate from interest and do not affect the allocation of the P&I payment. The choice "No principal reduction is permitted in the first year" is incorrect; standard fully amortizing loans reduce principal with every payment from the very first one. Exam tip: Link the high initial interest portion directly to the high starting balance. It's simple math: Interest = Balance * Rate.
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