More fun and exciting Q&A: “What does a mortgage payment consist of?”
Have you ever been curious what you’re paying each month to live in your shiny new (or possibly dingy old) home or condo?
A mortgage payment, assuming it’s not an interest-only loan, consists of a principal and interest portion, as well as mandatory taxes and insurance.
There’s a handy acronym to sum it all up, known as PITI; usually lenders want “X” number of months of PITI for cash reserves if you’re verifying assets when you apply for a loan.
The principal portion of your mortgage payment is essentially the amount of debt you are borrowing, which eventually transitions into your ownership in the home, or home equity.
The interest portion of your mortgage payment is the cost of borrowing the money for the loan, or the price the bank or mortgage lender charges for taking on the risk.
The tax portion of the mortgage payment is paid to the local government based on the assessed property value and tax rate for the area.
Finally, the insurance portion of the mortgage payment covers homeowners/hazard insurance, which protects the borrower from a number of dangers and provides liability coverage.
Note that if your loan-to-value exceeds 80 percent on a single loan, you’ll also have to pay private mortgage insurance.
FYI, an interest-only loan carries a mortgage payment that only pays off the monthly interest, taxes, and insurance, meaning you can only build equity in your home if the property value appreciates.
How the Mortgage is Paid Off
In the beginning, mortgage payments primarily go toward paying off interest because the loan balance is so high.
Over the years, as that balance decreases, more of the monthly mortgage payment goes toward principal each month until you eventually own the home outright.
This explains why some savvy homeowners choose to make biweekly mortgage payments, thereby increasing the amount of principal paid early on and decreasing the amount of interest paid over the life of the loan.
No one enjoys making mortgage payments every month, but knowing where that money is actually going should make you a more informed borrower.
