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? Or how much it might cost per month to acquire such real estate?
Let’s learn more about what goes into a home loan payment so you can better estimate your total monthly outlay, or if you’re a first-time home buyer, narrow down an appropriate purchase price.
Knowing what it all costs is a cornerstone to the rent vs buy question, and also key to knowing how much house you might be able to afford if you decide to dive in.
What a Typical Mortgage Payment Includes
A monthly home mortgage payment, assuming it’s not an interest-only loan, generally consists of four key components:
- a principal portion
- an interest portion
- property taxes
- homeowners insurance
Mortgage Payment = PITI
There’s a handy acronym to sum up the mortgage payment calculation known as “PITI.” When you say it, it sounds like “pity.” And I suppose it is a pity that we have to make mortgage payments every month, often for a staggering 30 years…or 360 months, but I digress.
Anyway, mortgage lenders typically want “X” number of months of PITI for cash reserves if you’re verifying assets when you apply for a home loan. In short, this tells the underwriter you can actually pay back the loan, at least for a few months…
Lenders will also use the PITI payment to determine your monthly housing expense, which is then used to calculate your DTI ratio. So it’s pretty important!
Let’s look at each portion of the overall loan payment to get a better understanding of what you’re paying each month.
The principal portion of your payment is essentially the amount of debt you are borrowing, which eventually transitions into your ownership in the home as it is paid back, also known as home equity.
The interest portion of your payment is the cost of borrowing that money for the loan, or the expense the bank or mortgage lender charges for taking on the risk.
The tax portion of the 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 payment covers homeowners/hazard insurance, which protects the borrower (and lender) from a number of dangers and provides liability coverage.
Does the Mortgage Payment Include Insurance?
- Your monthly mortgage payment may include insurance
- Including both homeowners insurance and PMI (if applicable)
- If your loan is escrowed/impounded
- Impounds are required on loans with LTVs above 80%
- And also on FHA loans, VA loans, and USDA loans
For those with a mortgage impound account (typically required for a high LTV loan over 80%), taxes and insurance are paid monthly as part of the overall mortgage payment. So you’ll pay the full PITI payment each month, as discussed above.
Instead of paying the mortgage and taxes/insurance separately, you’ll make an installment payment each month that covers all of those items. Then when taxes/insurance are due, they’ll be paid from those proceeds, which are held in an escrow account.
If you aren’t subject to impounds, you must pay taxes and insurance directly to the tax office/insurer once or twice a year, and the mortgage payment each month will consist of only principal and interest.
This can be a relief on a monthly basis, but make sure your good about saving money to pay for taxes and insurance when they are due. I’ve had friends who forgot they were on the hook for a big property tax bill, and didn’t save accordingly.
If you’re unsure of what’s included in your mortgage payment, simply call your loan servicer or check out your payment breakdown on the servicing website. It’s best not to leave anything to chance.
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 costs, which is one reason why putting 20% down can be a smart move.
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.
If we’re talking about a negative amortization loan, such as the once popular option arm, making the minimum payment wouldn’t even cover the interest due each month. Of course, you’d still have to pay the required taxes and insurance.
* You may also see the acronym “PITIA,” which stands for principal, interest, taxes, insurance, and association dues. This may apply if there is an HOA that charges due for your property each month.
How Are Mortgage Payments Applied?
- Because of the way mortgage loans are amortized
- Early payments consist mostly of interest
- With a small proportion going toward principal
- Over time this shifts until monthly payments are mostly principal
In the beginning of the loan term, mortgage payments primarily go toward paying off interest because the loan balance is so high.
While this may be viewed as a negative, it does mean mortgage interest tax deductions are bigger and more beneficial early on.
Over the years, as the outstanding balance decreases, more of the monthly mortgage payment will go toward principal each month until you eventually own the home outright. This is how amortization works.
It also 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.
As a rule of thumb, the longer your loan term, the more you’ll pay in interest because the loan is paid off slower. If you’re able to accelerate your payoff, you’ll pay less interest.
What Will My Mortgage Payment Be?
- Add up the following items (not all may be applicable)
- Property taxes
- Homeowners insurance
- HOA dues
- Mortgage insurance
- Flood insurance
If you’re trying to figure out what you’ll be paying your lender each month, consider all the ingredients of a mortgage payment and your mortgage rate.
You start with the home’s price, which will be driven by the health of the housing market.
Know that loan rates can vary tremendously based on loan type, with adjustable rates generally a lot cheaper than fixed rates.
For example, a 5/1 adjustable-rate mortgage will result in a lower payment than a 30-year fixed mortgage.
Your credit score is also a huge factor, as is down payment. And be sure to compare rates along the way because they can vary a ton between lenders!
If we’re talking jumbo loans, you might be hit twice – once for the large loan amount (higher home value associated with the jumbo) and a second time in the way of pricing, which tends to be higher than that of conforming loans.
As noted, if you’ve got an impound account, add up the principal, interest, taxes, and insurance. Those last two bits will be determined by your lender, so ask them to break it down.
The principal and interest portion is something you should be able to calculate on your own. Simply plug your loan amount and interest rate into a mortgage calculator to figure out the monthly payment.
If it’s interest-only, plug those two items into an IO calculator. Principal will no longer be part of the equation.
Don’t forget the extras. Do you need to pay mortgage insurance premiums each month? For example, there are monthly mortgage insurance premiums on FHA loans that must be paid.
What about monthly HOA fees? If it’s a condo, there probably are, though you might pay them separately to the association and not your lender.
Either way, it’s good to know what your total housing payment will be so you can budget accordingly.
Once you have all this key information, you can fire up a home affordability calculator to see what it’ll all set you back.
The mortgage interest rates and payments you see advertised typically only include principal and interest. That makes them look relatively cheap. Once everything else is added, the payment can look a whole lot different.
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 even save you some money! Certainly don’t make a home buying decision without knowing the answer to this core question.
Read more: When do mortgage payments start?