What Goes into Your Monthly Mortgage Payment?
Buying a house is one of the biggest financial commitments you’ll make in life. While many people only consider the total sale price of a house to determine if it’s within budget, it’s also important to think about what the monthly mortgage payment will consist of. A mortgage is a long-term loan designed to help you buy a house and the monthly payments can range considerably depending on a variety of factors like the length of loan, type of loan, and down payment. The easiest way to understand the components of a mortgage payment is through the acronym PITI. PITI stands for principal (the total price of the house), interest (the rate set by your lender or bank), taxes (the tax rate set by the government based on location, size of the house, and other factors), and insurance (peace of mind for you in case of emergencies and peace of mind for lenders if your down payment is below 20% and you use a conventional loan). To better understand each of these components that go into a monthly mortgage payment, we’ve broken them down below.
Principal and interest explained
When buying a house through a bank or lender, you are making a contractual agreement to pay the full sale price of the house back in addition to a percentage of interest. An interest rate is the amount a lender or bank charges a borrower and is a percentage of the principal (total amount loaned). These fees are charged on top of the principal as a payment for using the lender's assets to purchase a home. Interest rates are set once a loan is closed and are applied to the total amount of the loan. The bank or lender applies the interest rate to the loan balance with each monthly payment on a sliding scale. While interest rates are applied to almost any type of loan (credit card, education, etc.) mortgage payments typically have two types of rates: fixed rates or variable rates. Fixed rates are the same rates throughout the entire life of the loan and variable rates are subject to change throughout the life of the loan. In summary, the principal payment is a percentage of the monthly payment that is allotted towards the full price of the home and the interest payment is the percentage of the monthly payment that is allotted towards paying back the lender or bank.
How taxes and insurance factor into monthly payments
Real estate taxes are used to help fund public services like schools, police forces, fire departments, and more. These tax rates are calculated annually by the government and are charged to you on a monthly basis as part of your mortgage payment. The payments are held in escrow until it’s time to pay the annual taxes and when they are due, your lender or bank will use the money in escrow to cover the tax bill. Another factor that goes into your monthly payments includes insurance. Similar to how taxes are held in escrow until due, insurance payments are made each month and then paid out at the end of the cycle by your lender or bank to the insurance company. The two main types of insurance that may be included in your monthly payment include property insurance which is protection from disasters like fire and theft and PMI, which is added to loans that have been secured without a 20% down payment. There are some loan programs like VA Loans that waive PMI, which makes it a much more affordable monthly payment.
