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What Makes Up a Mortgage Payment?

Most homeowners get a mortgage to finance the purchase of their home. It is very rare that homeowners will use cash they have on hand in order to fund the purchase price of their home, simply because homes cost hundreds of thousands of dollars.

Because of the high purchase price of homes, mortgages were created as a loan product to provide affordable monthly payments to homeowners. These loans are typically spread out over a longer period of time than, say auto or personal loans, with most mortgages having a 30-year repayment period.

Another unique aspect of mortgages compared to other types of loans is that they include multiple parts. This can make calculating your potential mortgage payment challenging as compared to another type of loan.

Below, we'll look at all the different components of a mortgage payment. Not all of these components will necessarily apply to you, but these are all the potential parts of your monthly payment.

Mortgage Principal

The mortgage principal is the amount of the total purchase price that you are financing through the loan. In other words, it's the total purchase price minus any down payment that you made or concessions that the seller gave to you.

So, for example, if the purchase price of your home was $200,000 and you made a 20% down payment (or $40,000), then the amount you are financing is $160,000. That is considered your mortgage principal.

The way mortgages work is that this principal isn't split evenly among all your monthly payments. Instead, they are structured with a much lower amount going to principal at the start of the loan and a much larger amount in the latter stages of the loan.

Much of the mortgage payments you'll make in the first few years of the loan will be applied toward the interest the lender is charging.

Mortgage Interest

Interest is how lenders make money off the mortgages they offer to their customers. It is what they keep in exchange for lending buyers the money they need to purchase their homes.

The higher the interest rate, the higher the mortgage payment will be. A difference of even 1 percentage point can have a big effect on the total monthly mortgage payment. For example, a 3.99% interest rate on a $200,000 mortgage could result in you paying $111 more per month than if you got a 2.99$ interest rate.

Again, your monthly mortgage payment will go more toward interest in the earlier years of the mortgage, with less going toward interest in the latter part.

Keep in mind, though, that your monthly mortgage and insurance payments will remain stable throughout the life of your mortgage if you get a loan with a fixed rate. The only thing that will change is to what your monthly payment amount is being applied.

Mortgage Insurance

Depending on the type of mortgage you have, and the amount of your down payment, you may be required to pay what's called Private Mortgage Insurance, or PMI. Lenders add PMI to mortgage payments to mitigate their risk in certain situations.

Borrowers who don't make a down payment of at least 20%, for example, are required to pay PMI. Mortgage insurance can be costly. The amount you pay will be determined based on a set interest rate, which will be applied to the total amount of money that you finance. 

The major downside to PMI is that it's not money that you will get back or see a direct benefit to. It's not going to lower your principal amount, for instance, and is just extra money you need to pay with your mortgage.

The alternative, of course, is you might not be approved for a mortgage at all if there was no PMI. So, some borrowers may be OK with PMI, since it allows them to own a home.

Also keep in mind that some lenders will drop the PMI from your mortgage payment once you achieve 20% equity in your home. You can also refinance your mortgage down the line into a loan product that wouldn't require PMI, which could save you a significant amount of money.

Escrow

Escrow is a way in which homeowners can pay for two additional home-related expenses through their mortgage. Instead of paying these separately on an annual, quarterly or monthly basis, you will have the option of rolling these into your mortgage payment.

You are not charged interest on either of these two components, so there is no additional cost to doing it. Some lenders will even require you to place these two items into escrow, especially if you're a first-time homebuyer and/or if you're in the early stages of your loan.

These two items are discussed more below.

Homeowners Insurance

Almost all lenders will require borrowers to carry homeowners insurance. Not only does it protect you as the homeowner if anything should happen to your home or property -- or to someone while they're on your property -- but it protects the lender's investment as well.

Homeowners insurance will provide monetary coverage in case your home sustains damage from things such as fire, wind and other some weather-related events. It will also provide protection in case your home is burglarized, or if someone sues you because they were injured on your property.

Instead of paying the insurance company directly for this coverage, you can add it to your monthly mortgage payment. You'll pay a certain amount each month as part of your mortgage payment. That will then go into escrow, and your lender will pay the insurance company when that bill comes due. In fact, the insurance company will even send the bill directly to your lender, so you don't have to be involved at all.

Property Taxes

Property taxes are issued by states and local governments as a way to fund many public projects. This includes public schools, trash and recycling collections, road maintenance, and fire and police departments, for example. 

The amount you pay in property taxes will be determined as a percentage of your home's assessed value. Taxes are typically assessed once a year, and are due to your local municipality on a quarterly basis. 

This is another bill that you can pay as part of your mortgage payment through escrow. It works exactly the same way as property insurance does. Your annual tax bill will be split into equal monthly payments. Those payments will be added on top of your mortgage and insurance amount.

When you make your payment each month, the dedicated property tax portion will be put into an escrow account, and your lender will pay your property tax bill when it comes due.

Again, the municipality will send the bill directly to your lender, so that you don't have to be involved at all.

 

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