What Does a Mortgage Payment Consist Of?

More fun and exciting mortgage 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.

Mortgage Payment = PITI

There’s a handy acronym to sum it all up, known as PITI.  Typically, mortgage lenders want “X” number of months of PITI for cash reserves if you’re verifying assets when you apply for a loan.

This tells the underwriter you can actually pay back the 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, also known as home equity.

The interest portion of your mortgage payment is the cost of borrowing the money for the loan, or the expense 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: If your loan-to-value exceeds 80 percent on a single loan, you’ll also have to pay mortgage insurance on top of the aforementioned.

And the mortgage payment on an interest-only loan consists of just 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.

Doing so will also shorten your mortgage term, which is beneficial if you want to own your home sooner, but don’t want the commitment of larger payments associated with certain loan programs such as the 15-year fixed.

In summary, no one enjoys making mortgage payments every month, but knowing where that money is actually going should make you a more informed borrower.  And it could save you some money!