What is Mortgage Payable
Added: (Sat Nov 04 2017)
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The term mortgage means long-term financing that is used to purchase property, which itself, serves as collateral for the mortgage until it’s paid off. During the period equal payments, including principal and interest are essentials for a mortgage. However, the first payments include more interest than principal and over the life of the mortgage principal portion increases and interest portion decreases. The reason why interest decreases is because interest is calculated on the outstanding principal balance which decreases as the mortgage payments are paid.
To make it clear, let’s work over it with an example. Someone obtains a fifteen year $175,000 mortgage with interest rate %7.5 and $1,622.28 monthly payment. The borrowing and receipt of cash are recorded with increase (debit) to cash and increase (credit) to mortgage payable. As soon as a payment is made, mortgage payable is declined for the principal portion of the payment, interest cost is increased for the interest portion of the payment, and by the payment which is $1,622.28, cash is declined. In the first payment the portion of interest is $1,093.75 that is calculated by multiplying the $175,000 (principal balance) times %7.5 (interest rate) times 1/12 (since payments are made monthly).
With this way, interest of the second portion is $1,090.45. The reason why it is different than the first payment is, the outstanding principal balance was increased by $528.53, which is difference between first payment amount and first interest expense. The second interest is calculated by multiplying $174,471.47 (principal balance) times %7.5 (interest rate) times 1/12. Until the mortgage is paid off, this method to calculate the interest continues. The difference between the cash paid and the interest cost of each payment shows the principal portion. The entries to record the receipt of the mortgage and the first two installment payments are.