It is essential to know your monthly mortgage payment, whether you are in the process of buying a home or have an ongoing mortgage. Your mortgage payment contains several different parts that collectively decide how much you pay each month. Learning what these parts are and how they interact enables you to plan your finances properly and make the right financial choices. Here, we’ll dissect all the components that usually go into a monthly mortgage payment, describe how each one operates, and provide information on how payments may fluctuate over time.
What Exactly Is a Monthly Mortgage Payment?
A monthly mortgage payment is the amount you send each month to your lender or loan servicer to pay for the expenses involved with your home loan. This payment typically consists of several components, such as the principal, which is what you borrowed and are slowly paying off. The majority of your monthly mortgage payment goes toward paying down the loan’s original balance. And property taxes pay for local government services.
There are also homeowners insurance, which covers your property and possessions; private mortgage insurance (PMI), which you might be required to pay if your down payment was not more than 20%; and, if you are in a community with a homeowners association (HOA), HOA fees every month. Each component adds to your total monthly housing cost, so knowing what you’re getting can enable you to plan better.
Principal: Paying Down Your Home Loan Balance
The majority of your monthly mortgage payment goes toward paying down the loan’s original balance. When you initially begin paying your mortgage, a lower percentage of your payment contributes toward the principal, with most going toward interest. As time passes, this reverses itself; the principal percentage grows, and the interest declines.
This gradual repayment is because of amortization, a method where your loan is designed so you are paying interest and principal in increments over a set number of years, usually 15, 20, or 30. At the end of the mortgage term, the full principal amount is repaid, and you have your home free and clear.
Understanding this breakdown is important because paying extra toward the principal early on can significantly reduce the total interest paid over the life of the loan and shorten your mortgage term.
Interest: The Cost of Borrowing
The interest component of your monthly mortgage payment is the cost your lender is charging you to borrow funds. Interest is a percentage of the outstanding principal balance. This percentage can be a fixed rate, in that it remains the same over the life of the loan, or an adjustable rate, in that it may change based upon prevailing market conditions after an introductory period that was fixed.
Fixed-rate mortgages have a fixed monthly payment and interest rate for the entire term of the loan, making budgeting easier. For adjustable-rate mortgages (ARMs), your interest and therefore your payment can vary, introducing uncertainty. Since interest is charged on the outstanding balance of the principal, as you reduce the principal, your charges for interest slowly decrease.
Property Taxes: Funding Your Community
Property taxes are imposed by your local government and are assessed on the value of your property. They pay for necessary public goods and services like schools, police and fire services, road maintenance, and other municipal requirements.
Most lenders collect property taxes as part of your monthly mortgage payment through an escrow account. They then pay the tax bill on your behalf when it’s due, typically once or twice a year. Property taxes can vary widely depending on where you live, so it’s important to research local rates before buying. Additionally, property tax assessments can change over time, which can cause your monthly payment to increase or decrease.
Homeowners Insurance: Safeguarding Your Investment
Homeowners’ insurance insures your house and personal property against loss or damage caused by fire, theft, storms, and other forms of damage. It’s a necessary evil for nearly all mortgage holders to secure the property, which is their collateral.
Similar to property taxes, homeowners’ insurance premiums are typically paid monthly through escrow and forwarded by your lender. The price of homeowners’ insurance varies according to such factors as your home’s location, age, replacement cost, and policy limits. It makes sense to comparison shop between insurance companies and policies to obtain the lowest premium.
Private Mortgage Insurance (PMI): What It Is and Why You Might Pay It
If your down payment is less than 20%, most lenders will need private mortgage insurance (PMI). PMI protects the lender if you do not make your payments.
PMI often adds a monthly premium to your mortgage payment, ranging from 0.3% to 1.5% of the original loan amount every year, divided into monthly installments. While it increases your expenses, PMI allows borrowers with minimal down payments to obtain loans. You may be able to ask for PMI cancellation when you attain 20% equity in your property, either through principal reduction or appreciation of the property.
Homeowners Association (HOA) Fees: For Living in a Community
If you buy a house in a community with a homeowners association, you will probably have to pay HOA fees. HOA fees pay for common area maintenance, landscaping, security, and community amenities such as pools or gyms.
If your lender demands, HOA costs can be included in your monthly mortgage payment; otherwise, you can pay them separately. HOA fees should be factored into your overall house budget, as they can range from low to high depending on the neighborhood. A fixed-rate mortgage typically has the same interest and principal payments each month. But other components of your mortgage payment may vary, so your overall monthly payment may increase or decrease.
How Monthly Mortgage Payments Can Change Over Time
Property Taxes Can Increase
Property taxes are based on how much your home is worth and the local tax rates. If your home’s value goes up or if the local government raises taxes, your property tax bill will increase. This means your monthly mortgage payment will be higher.
Homeowners Insurance Costs May Rise
Homeowner’s insurance covers your home from loss or damage. Occasionally, insurance rates rise if you get money back on a claim or if the insurance company raises its rates. So, your insurance premiums and your monthly mortgage payment might go up.
Private Mortgage Insurance (PMI) Typically Terminates
If you didn’t put 20% down when you purchased your home, chances are you pay PMI. This additional amount of money keeps the lender safe in case you fail to pay the loan. Fortunately, when you own enough of your home (typically 20% equity), you can discontinue paying PMI. When you do this, your monthly payment will decrease.
Adjustable-Rate Mortgages
If you have an adjustable-rate mortgage (ARM), your interest rate will likely change after a specific period. Your monthly payments can increase or decrease based on interest rates. This makes your mortgage payments more unpredictable.
A monthly mortgage payment consists of several elements: principal, interest, property taxes and homeowners’ insurance, and potentially PMI and HOA fees. Although principal and interest are the central loan payments, taxes and insurance tend to comprise a significant portion of your monthly charge. Knowing what each component is and how they work together gives you the power to budget, plan, and control your homeownership expenses successfully.
Whether purchasing your first home, refinancing, or just wanting to better understand your finances, it will serve you well to know what is contained in your mortgage payment. It will enable you to make sound decisions and stay away from surprise expenses.
FAQs
1. Can I reduce my monthly mortgage payment without refinancing?
Yes. You may be able to lower your monthly payment by canceling PMI once you reach 20% equity, challenging your property tax assessment if it’s too high, or shopping around for cheaper homeowners insurance. Each of these components affects your escrow balance and can help reduce your total payment.
2. What happens if I miss an escrow payment for taxes or insurance?
If you miss a mortgage payment that includes escrow, your lender might still pay your taxes or insurance on your behalf to prevent default, but you’ll become delinquent on your mortgage. This could result in late fees, credit score damage, and even foreclosure if not addressed quickly.
3. Are HOA fees always included in my mortgage payment?
Not always. Some lenders allow or require you to pay HOA fees separately, while others can include them in your monthly mortgage bill if agreed upon in advance. Either way, HOA fees are mandatory if your home is part of an association, so be sure to account for them in your housing budget.
4. Will my monthly mortgage payment go down over time?
It depends. The principal and interest on a fixed-rate mortgage stay constant, but escrow items like taxes and insurance can change. Your payment might decrease if PMI is removed or insurance costs drop, but it’s also common for payments to rise due to property tax increases or higher insurance premiums.
5. How is my monthly payment calculated if I make a large extra payment toward the principal?
A large extra payment reduces your principal balance, which means less interest accrues going forward. On a fixed-rate mortgage, this won’t change your monthly payment but will shorten your loan term and reduce total interest. On some loans, especially ARMs or re-castable loans, it can lower your future monthly payments, too.
