Were you shocked when you learned your mortgage payments were higher than expected? Such a surprise happens when you don’t factor all the components of a mortgage.
What is included in a mortgage payment?
A mortgage is made of principal, interest, insurance, and taxes. Your principal is the starting balance, and lenders add the remaining parts to the principal. This article will provide an in-depth view of a mortgage payment. Let’s explore.
The principal entails the amount you borrowed. Overall, it comprises the meat of your home loan. If you borrowed $250,000, for example, your principal is $250,000.
Anything higher than $250,000 means lenders included taxes, insurance, and interest to the balance. The payments you make each month will lower the principal.
Your principal will change as you make payments. Your principal balance will remain high at the start of the loan. How fast the balance dwindles depends on the terms and the payment structure.
- Example: Payment terms can stretch 25 years or longer. Within 25 years, you’ll make monthly payments until you pay off the balance.
In many cases, the payments made in the beginning will pay off the interest. For the most part, payments made in the first five years will go to the interest.
Since mortgages can last several decades, lenders also want to get a short-term profit in the form of interest. Over time, however, you’ll pay off more of the principal.
You build more equity as you pay down the balance. Equity is a portion giving you an ownership stake. You own more of the home as you build more equity.
If you want to pay more of the principal to build additional equity, you can issue prepayments. A prepayment is the additional money you pay to reduce the principal. However, you don’t have to pay an exorbitant sum to lower the balance.
Making one extra payment a year can shave years off your mortgage term. If you want to know How to Pay Off Your Mortgage 4-12 Years Sooner, continue paying beyond the minimum balance consistently.
The interest involves the lender’s risk in loaning money. Lenders also give loans to make money off the interest. Interest is one of the main factors that increase your monthly payments. There are two main types of interest rates:
- Compound Interest: Lenders determine the interest based on the loan balance and the accrued interest. This means you’ll pay interest on top of interest, including the principal.
- Simple Interest: Lenders determine the interest on the principal alone. It’s a fixed percentage stemming from the loan balance.
Higher interest rates mean higher payments overall. Further, a typical monthly payment may entail more interest than principal.
- Example: If you’re making a $600 monthly payment on a 30-year mortgage, $500 of that payment could be the interest, and $100 could be the principal.
To minimize interest accumulation, you should pay beyond the monthly minimum. This is especially important in cases where interest makes up a large part of your monthly payment.
Additionally, it’s important to find a mortgage with a lower interest rate. A higher interest rate can make your mortgage more expensive.
Making high payments may seem feasible in the beginning. However, continued payments on a pricey mortgage will be tougher over time, especially if you encounter financial difficulties in the future. A high-rate mortgage is a primary reason why so many homeowners fall behind on payments.
You’ll come across two types of mortgage insurance: private mortgage insurance (PMI) and property insurance. Property insurance protects you (the homeowner) in the event of an emergency, such as theft or a natural disaster.
The cost depends on your state. You could pay anywhere from $1,000 to $4,000 a year in property insurance. In Hawaii, you could pay as low as $500 annually.
When it comes to mandatory coverage, property insurance usually isn’t compulsory. However, the lender may require some form of coverage to process the loan.
PMI protects the lender in case you default. PMI benefits the lender alone, not you or your family members. It also allows lenders to sell the mortgage to other investors as guaranteed returns.
In terms of cost, PMI can range between 0.5% to 1% of the loan balance. This means you could pay anywhere between $80 to $1,000 a month in insurance costs.
PMI is more stringent, and many mortgage companies require PMI if a borrower pays less than 20% down. In other cases, lenders may still require PMI even if you pay the full 20% down.
The taxes consist of property taxes you pay to government agencies. Property taxes fund schools, police, fire stations, etc. Governments calculate taxes annually.
Lenders factor the tax balance into your monthly payments. From there, the lender collects the taxes and places them in an escrow account until the tax due date.
The tax cost depends on the state, but they average around $2,300 nationally. In some states, you could pay $3,000 or more annually in property taxes.
What is Included in a Mortgage Payment Overall?
If you’re wondering, “What is included in a mortgage payment in total?”, the parts of a mortgage include principal, interest, taxes, and insurance. The principal is the largest component of a mortgage balance. However, the interest can comprise a large part of your monthly payments.
Taxes and insurance are smaller parts of the mortgage, but the small additions can make your payments more expensive. To avoid surprises, use a mortgage calculator to incorporate all parts of your mortgage payments.
Interested in learning more about what makes up a mortgage payment? Read more on our blog to gain insight into mortgage-related topics.