Homebuyer Help: What is included in a Mortgage Payment
You’re ready to become a homeowner! It’s an exciting time and now you may be wondering what exactly is included in a monthly mortgage payment, and how much it will actually be. We are here to help you with that so you won’t be surprised by the monthly expense.
What is Included in a Mortgage Payment?
A mortgage payment is typically billed at the beginning of each month and is made up of 4 components. These are the Principal, Interest, Taxes, and Insurance (PITI), as defined below.
- Principal – Part of the monthly payment that reduces the remaining balance of the mortgage. The percentage of the payment that goes toward principal will change over time.
- Interest – The fee charged for borrowing money. This rate is determined during the loan application and approval process. The Annual Percentage Rate (APR), is a yearly rate including interest, mortgage insurance, and loan origination fees.
- Taxes – The monthly cost of property taxes for the home you purchase.
- Insurance – The monthly cost of homeowners and/or private mortgage insurance for the home you purchase.
Taxes and Insurance Payment Options
The taxes and insurance portion of the payment may either be included in the monthly payment to the mortgage servicer and held in an escrow account (link is external) or paid directly by homeowners themselves.
- Escrow Payment Option – The mortgage company will get your property tax bills and homeowners/private mortgage insurance bills and estimate a monthly amount to cover them. They will collect that amount from you as part of your monthly mortgage payment and hold it in an escrow account. They will pay the bills from this account as they become due.
- Self Payment Option – You will not include the estimated amounts in your monthly payment and instead pay your property tax and homeowners insurance directly when the bills are due. Make sure to set aside enough funds on a regular basis to make these payments since they are not usually monthly.
Most borrowers choose the escrow account option because it saves the trouble of remembering to set aside the funds and pay the bills directly when they come due. Monthly escrow payments are estimated and adjusted by your mortgage servicer on an annual basis. Funds in an escrow account also earn a small amount of interest.
How is a Mortgage Payment Calculated?
Your monthly payment is calculated using a formula that involves the APR and amortization tables and includes the components mentioned above. But you don’t need to be a math expert to estimate a payment amount!
You will notice that the amount of principal that you owe on a home loan will not decrease by the same amount through your loan term. A large portion of your monthly payments in the beginning years of the term will go toward interest costs. As time goes on and your principal amount decreases, more of your monthly payment amount will go toward the principal amount, reducing it at a faster rate. This does not change the loan term or your payment amounts.
Planning for Mortgage Payments
Through your home loan process, you’ll be given the exact amount of your upcoming monthly mortgage payments, which will help you plan for the expense. It’s a good idea to set aside 2-3 months worth of mortgage payments at the beginning so that you don’t risk falling behind if anything unexpected happens.
You will actually prepay your beginning mortgage payment in the closing costs of your home loan, so when you move into your home, you will have a delay until the following month before you start sending your monthly payments to your mortgage servicer. Try setting aside the amount you would have paid that first month toward future mortgage expenses.
Additional Mortgage Payment Resources
As you consider your monthly mortgage payments, check out our other posts to see how changing the way you make your payments might impact your home loan:
- Paying Biweekly Payments vs. Monthly Mortgage Payments
- How Making One Extra Mortgage Payment a Year Can Benefit You
Now that you have a better understanding of what is included in a mortgage payment, it will be easier to estimate your monthly expenses and take some of the mystery out of the homebuying journey.