August 22, 2022
The Anatomy of a Mortgage Payment
There are four parts to a mortgage payment:
- Principal – A portion of your mortgage payment is dedicated to repayment of the principal balance. Loans are structured so that the amount of principal returned to the borrower starts out low and increases with each mortgage payment. This calculation method is commonly referred to as amortization. The early year payments apply more of the monthly payment to interest than principal, while the payments in the final years are reverse.
- Interest – Interest is the lender’s reward for taking a risk and loaning the money. The interest rate on a mortgage has a direct impact on the size of the payment. Higher rate means a higher payment. Higher interest rates generally reduce the amount of money you can borrower by driving up your debt-to-income ratio, determining how much payment you can afford in relation to your monthly income and other debt obligations.
- Taxes – Real Estate or property taxes are assessed by government agencies and used to fund public services such as schools, police forces, and fire departments. Taxes are calculated on an annual basis, but you can elect to pay this expense as part of your monthly payments by using an escrow account. The lender collects the payments and holds them in escrow until they must be paid, and the lender handles the payment. Taxes change annually as assessed by the government and they usually go up. While the Principal and Interest part of your payment will remain the same, the Escrow portion is subject to change annually. Your lender will notify you of any changes.
- Insurance – Like real estate taxes, insurance payments are made with each mortgage payment and held in escrow until the bill is due. This payment amount can also change annually. There are different types of insurance:
- Homeowner’s Insurance – this insurance is a requirement for every mortgage loan and insures the house (lender’s collateral).
- Flood Insurance – if the property is found to be in a flood zone, flood insurance is required.
- Private Mortgage Insurance (PMI) – you may be required to pay for PMI if your down payment is less than 20% of the property value.