In order to understand interest rates, it is important to have background knowledge on mortgages. A mortgage is a loan that you receive from a lender or bank that is secured by a property, your home. Once you have chosen the right mortgage, you make monthly payments to repay the lender. The monthly payment has two parts to it, the principal and the interest. The monthly payment may include property tax and home insurance, as well.

The principal is simply the money that the bank lent you for the house. For example, you save up $20,000 and the house costs $150,000 you would need to borrow $130,000. After you borrow the $130,000, that amount will go to the seller of the home that you are looking to purchase.

Mortgage lenders make their money by charging you interest on top of the principal. The amount of interest you pay depends on the amount the loan is for and the interest rate. Overall, the lower the interest rate and the shorter the time it takes for you to pay the lender back (term), the lower the amount you will pay.

If the interest rate is 6.25%, we can easily calculate the monthly payment based on the previous example. The monthly cost would be $677.08 per month. We got that by multiplying the principal, $130,000 times the interest rate 6.25% and dividing that by the number of months, 12. ($130,000x.0625)/12= $677.08. It is important to keep in mind that as your loan principal decreases so does your interest expense. In the first 15 years of the term, you will be paying more money on the interest. On the other hand, the last 15 years the money mostly goes towards paying off the principal.

Paying off a loan over 30 years is very expensive. An alternative is to get a loan for only 15 years. This will help you save more money in the long-term and also finish paying off the home sooner. You will end up paying a lot less money on interest with the 15-year loan agreement. On the other hand, your monthly payments will be higher because you are paying more of the principal each month.

This is not suggesting that everyone should go for the 15-year loan agreement. Every case is going to be different and you should choose your loan term based on your financial situation. If you can afford to make the higher monthly payment with the 15-year term and without sacrificing too much, then it is advisable to do so. On the other hand, if you are sacrificing too much just to save the money after 15 years, it might be best to go with the 30-year term agreement. There are also adjustable-rate mortgages that you could choose. These are where the interest rate varies based on the market. It is important to consult with your mortgage lender before choosing the term limit and the type of mortgage: fixed or variable. He or she would be able to give you the loan that better fits your personal needs.

Overall, in order to save the most money you need to have a shorter loan agreement and a low interest rate. The lowest interest rate should not be the only reason for choosing a particular lender though. Having personal service is definitely worth the minimal extra interest that you might have to pay.